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THE  OPERATION  OF 
THE  NEW  BANK  ACT 


THE  OPERATION  OF 
THE  NEW  BANK  ACT 


BY 

THOMAS   CONWAY,  Jr.,  Ph.D. 


PBOFE8SOB   OF   FINANCE 


AND 


ERNEST  M.  PATTERSON,  Ph.D. 

INSTRUCTOR    IN   FINANCE 

WHARTON  SCHOOL  OF  FINANCE  AND  COMMERCE 
UNIVERSITY  OF  PENNSYLVANIA 


FIFTH  IMPRESSION 


PHILADELPHIA  AND  LONDON 
J.  B.  LIPPINCOTT  COMPANY 

3460^5 


COPYBIQHT,     1914,    BY    J.    B.    LIPPINCOTT   COMPANY 


PRINTED    BY    J.    B.    LIPPINCOTT    COMPANY 

AT   THE    WASHINGTON    SQUARE    PRESS 

PHILADELPHIA,    D.    S.    A. 


c-J 


PREFACE 

^2  To  issue  a  book  which  endeavors  to  analyze  the  effects 

'       of  a  monumental  piece  of  legislation,  marking  a  distinct 
7     change  of  policy  in  one  of  the  most  important  lines  of 
^     business  in  the  country  within  a  few  weeks  of  its  passage, 
is  unusual.    The  writers  would   naturally  prefer,   under 
ordinary  circumstances,  to  delay  publication  until  the  ex- 
perience of  several  years  had  demonstrated  the  law 's  advan- 
^     tages  and  defects.    If  this  volume  were  intended  as  a  cora.- 
^.     plete  estimate  of  the  effects  of  the  Federal  Reserve  Act,  such 
f"      a  course  would  be  necessary.     The  purpose,  however,  is  to 
give  whatever  assistance  may  be  within  the  authors'  power 
i     to  the  formulation  of  public  opinion  through  the  dissemina- 
V>   tion  of  such  information  as  is  now  available.     The  period 
rl   of  organization  is  a  critical  stage  in  the  life  of  the  law.    Its 
;    success  or  failure  will  depend  primarily  upon  the  degree 
^     to  which  bankers  and  the  public  at  large  give  intelligent 
cooperation  in  the  inauguration  and  operation  of  the  new 
^    system.    The  Federal  Reserve  Act  marks  such  a  pronounced 
^  departure  in  American  banking  methods  that  everj'  bit 
fv-^  of  light  shed  upon  the  new  conditions  will  be  helpful.    If 
'^   this  book  aids  the  banker  to  understand  more  clearly  the 
change  which  has  been  effected  in  his  business  and  informs 
the  public  at  large  concerning  the  nature  of  this  Act,  the 
authors  will  be  well  satisfied. 

The  authors  desire  to  express  their  indebtedness  to  their 
associate,  Mr.  Gordon  B.  Anderson,  for  valuable  assistance 
rendered  in  the  calculations  concerning  the  shifting  of  re- 
serves. Valuable  help  has  also  been  received  from  Miss 
Marion  Conway  and  Mr.  Earle  H.  Raudnitz,  in  verification 
and  proofreading. 

T.  C,  Jr. 
E.  M.  P. 
Philadelphia,  January  14,  1914. 


CONTENTS 

Chapter.  Page 

I.  The  Defects  of  the  Present  Banking  System 1 

II.  The  New  Law  Summarized 18 

III.  The  Regional  System 26 

IV.  Ownership 39 

V.  Federal  Reserve  Banks 51 

VI.    The  Problem  of  Control  of  the  New  System.  ...     67 
VII.    Powers  and  Duties  of  the  Federal  Reserve  Board 

Enumerated 76 

VIII.    The  Powers  op  the  Federal  Reserve  Board  Ana- 
lyzed      85 

IX.    Rediscounts 92 

X.    The  Business  of  Rediscounting 106 

XI.    Foreign  Acceptances 115 

XII.    Retiring  the  National  Bank  Notes 130 

XIII.  The  New  Reserve  Bank  Notes  and  Refunding 

THE  Bonds 138 

XIV.  The  Federal  Reserve  Notes 143 

XV.     Issuing  and  Retiring  the  Federal  Reserve  Notes  150 

XVI.    Possibility  of  Inflation 160 

XVII.    Open  Market  Operations 170 

XVIII.     Control  of  the  Gold  Supply 178 

XIX.    Government  Deposits  and  the  Relations  of  the 

Reserve  Banks  to   the  Government 184 

XX.     The  Reserve  Problem 202 

XXI.     The  Redepositing  of  Reserves  under  the  New 

Act 220 

XXII.    Readjustment  of  the  Reserves  in  the  Country 

Banks 240 

XXIII.  Readjustment  of  Reserves  in  the  Reserve  Cities  262 

XXIV.  The    Reserve    Problem    in    New   York    and   the 

Other  Central  Reserve  Cities 282 

vii 


VIU 


CONTENTS 


XXV.    The  Shifting  of  Reserves  in  the  Central  Re- 
serve Cities 297 

XXVI.    Final  Stage  in  the  Readjustment  of  Reserves  .  .  316 

XXVII.    Clearing  Checks  and  Drafts 323 

XXVIII.     Mortgage  Loans  on  Farm  Lands 332 

XXIX.     How  the  System  Will  Affect  the  Country  Banks    343 
XXX.     The  Reserve  City  Banks  under  the  New  Law.  . . .  354 
XXXI.    Effect  of  the  System  upon  New  York  and  Other 

Central  Reserve  Cities 359 

XXXII.     State  Banks  and  the  New  Law 368 

Text  of  the  "  Federal  Reserve  Act  " 379 

Index 407 


THE  OPERATION  OF  THE 
NEW  BANK  ACT 

CHAPTER  I 
The  Defects  of  the  Present  Banking  System 

The  National  Bank  Act. — For  fifty  years  the  United 
States  has  lived  rather  happily  under  the  National  Bank 
Act,  born  in  the  strife  of  the  Civil  War  and  developed  in 
the  period  of  the  nation's  greatest  expansion  and  growth. 
This  Act  has,  by  its  record,  earned  for  itself  a  place  as  a 
great  piece  of  constructive  legislation ;  and  the  recognition 
of  this  fact  is  responsible  for  the  preservation  of  our 
national  banking  system  almost  intact  under  the  Federal 
Reserve  Act.  The  National  Bank  Act  removed  the  ills  of 
wildcat  banking,  which  so  afflicted  the  country  prior  to 
the  Civil  War;  gave  us  an  absolutely  safe  form  of  money 
which,  although  not  legal  tender,  is  taken  without  question 
by  everyone ;  and  has  made  possible  an  enormous  expansion 
in  the  banking  resources  and  facilities  of  the  country.  In 
spite  of  the  denunciation  and  abuse  which  have  been  heaped 
upon  it,  the  Act  has  been  reasonably  satisfactory  in  opera- 
tion. Any  one  who  -reviews  the  figures  of  the  material 
growth  and  prosperity  of  the  nation  and  the  rise  of  its  finan- 
cial power  will  be  forced  to  the  conclusion  that  no  Act  that 
was  fundamentally  unsound  could  have  been  an  integral 
part  in  the  aehievenicnt  of  such  a  notal)le  record. 

United  States  Banking  Democratic. — Designed  for  the 
purpose  of  encouraging  a  system  of  independent  banks,  the 
Act  has  been  responsible,  directly  and  indirectly,  for  the 
creation  of  some  twenty-fivo  thousand  banking  institutions 
in  this  country,  practically  all  of  which  are  independent  of 
each  other.    Instead  of  a  small  banking  class  and  an  equally 

1 


2  OPERATION  OF  THE  NEW  BANK  ACT 

small  group  of  banks,  all  under  the  domination  of  one  or  a 
very  few  interests,  we  have  developed  a  system  of  banking 
which  has  sprung  from  the  people,  and  which  is  closer  to  the 
people  than  that  of  any  other  country.  Any  group  of  men 
having  a  comparatively  small  amount  of  capital  which  they 
desire  to  use  in  the  establishment  of  a  bank,  possessing  good 
reputations  and  having  earned  for  themselves  the  confidence 
of  the  community,  can  successfully  organize  a  banking  in- 
stitution. Banking  is  not  a  monopoly  in  the  United  States, 
and  one  of  the  strongest  features  of  our  banking  system  is 
the  fact  that  those  who  sit  upon  the  boards  of  directors  of 
our  financial  institutions,  who  pass  upon  loans  and  manage 
their  affairs,  are  business  men  upon  whose  judgment,  fore- 
sight and  conservatism  depends  the  future  of  the  republic. 

The  State  Banks. — Side  by  side  with  the  national  bank- 
ing system  have  grown  the  State  banking  systems  of  our 
forty-eight  commonwealths,  modelled  in  the  main  upon  that 
established  by  the  Federal  government.  The  increase  in 
these  State  institutions  has  been  very  rapid,  and  they  now 
outnumber  the  national  banks  about  three  to  one.  This 
growth  has  been  particularly  great  since  1900,  the  number 
having  more  than  doubled  since  that  time.  This  surpasses 
by  far  the  remarkable  record  of  the  national  institutions, 
and  has  been  one  of  the  most  striking  changes  in  American 
banking  conditions  in  this  generation. 

The  great  popularity  of  State  charters  is  the  result  in 
part  of  the  greater  latitude  and  broader  opportunities  for 
making  money  generally  conferred  by  them  as  contrasted 
with  those  granted  under  the  national  law.  To  some,  the 
less  strict  requirements  and  examinations  under  State  con- 
trol are  inviting.  This  situation  is  one  of  the  problems 
which  must  be  dealt  with  in  the  operation  of  the  new  bank 
act  and  the  management  of  the  new  system.  The  national 
government  is  handicapped  in  creating  an  ideal  banking 
system  by  the  fact  that  the  majority  of  the  banks  of  the 
country  are  outside  of  its  jurisdiction.  The  power  of  the 
States  to  charter  banks  forces  the  Federal  government  to 
adopt  a  conciliatory  attitude  in  its  effort  to  effect  banking 


DEFECTS  OF  PRESENT  BANKING  SYSTEM      3 

reform.  This  may  not  be  an  unmixed  blessing,  for  it  coun- 
sels moderation  and  the  avoidance  of  any  harsh  or  radical 
change. 

National  Banks  the  Stronger. — Although  the  national 
banks  comprise  only  about  one-third  of  the  total  number, 
they  possess  almost  one-half  of  the  aggregate  resources  of  all 
the  banks  of  the  country,  and  because  of  the  plan  of  organ- 
ization of  the  national  and  State  banking  systems,  they 
occupy  a  position  of  supremacy.  The  Federal  Reserve  Act 
is  planned  upon  the  theory  that  the  weaknesses  in  the 
national  banking  system  can  be  remedied,  and  the  defects 
in  the  American  banking  system  can  be  almost  entirely 
eliminated,  without  making  any  radical  changes  in  the  laws 
governing  the  State  banking  institutions. 

For  more  than  a  decade  there  has  been  persistent  agi- 
tation for  the  reformation  of  the  national  banking  system. 
Although  the  progress  of  this  country  has  been  rapid  and 
our  banks  have,  on  the  whole,  been  able  to  cope  with  the 
problems  presented  to  them,  yet  it  has  been  apparent  for 
many  years  that  the  whole  system  was  defective.  While 
business  has  not  been  throttled  it  has  been  cramped,  and  it 
is  difificult  to  tell  how  much  more  prosperous  we  would  have 
been  as  a  nation  had  these  defects  not  existed.  To  a  large 
degree  the  existence  of  these  imperfections  is  something  con- 
cerning which  the  Inisiness  man  has  been  unconscious,  except 
in  times  of  panic.  When  the  West  and  the  South,  for  the 
purpose  of  moving  the  crops,  withdraw  money  which  they 
have  deposited  in  the  eastern  banks,  we  have  a  season  of 
very  high  interest  rates.  This  situation  is  unknown  in  any 
other  well-developed  country  of  the  world.  The  paATnent 
of  these'  high  interest  rates,  the  scarcity  of  money  which 
they  betoken  mid  the  uncertainty  which  the  withdrawals 
from  the  eastern  banks  create,  are  a  check  upon  business 
enterprise. 

Our  Frequent  Panics. — During  perhaps  ninety-nine 
months  out  of  eveiy  one  hnndred.  the  banks  are  able  to 
meet  promptly  their  obliGrntinns  to  their  eustomers.  Checks 
can  be  cashed  without  delay,  money  transferred  by  draft 


4  OPERATION  OF  THE  NEW  BANK  ACT 

or  in  any  other  manner  the  customer  may  elect,  collections 
made  with  expedition,  loans  secured  where  a  good  bank 
risk  is  presented,  the  sale  of  securities  financed  and  all  the 
other  work  of  a  bank  successfully  conducted.  In  the  hun- 
dredth month,  however — frequently  without  adequate 
warning — a  financial  panic  may  suddenly  spring  up,  begin- 
ning with  some  comparativel}'  insignificant  event  in  a  far 
distant  part  of  the  country.  The  blight  spreads  with  light- 
ning rapidity  and  almost  over  night  the  exchanges  of  the 
country  are  paralyzed,  business  men  are  denied  credit  upon 
which  they  have  been  counting  and  which  they  badly  need, 
loans  are  refused  and  financial  chaos  and  disorder  are 
rampant.  It  takes  the  country  years  to  recover  from  the 
effects.  No  great  nation  of  the  world  has  been  afflicted  with 
so  many  panics  within  the  last  half  century  as  the  United 
States.  Business  has  struggled  through  the  panics  of  1873, 
1884,  1890,  1893,  1901  and  the  great  crisis  of  1907.  When 
we  consider  the  havoc  and  ruin  brought  by  these  financial 
convulsions  we  marvel  at  the  great  recuperative  power  of 
our  count^^^ 

Panics  are  psychological  phenomena.  They  are  akin  to 
a  stampede  in  a  theatre  at  the  cry  of  fire,  as  both  are  due  to 
a  latent  conviction,  which  suddenly  becomes  active,  that  the 
disturbance  will  mean  disaster  to  all  within  its  scope.  The 
conditions  which  breed  a  panic  are  slow  in  the  making,  and 
may  consist  of  either  commercial  or  financial  excesses.  Com- 
mercial crises  can  not  entirely  be  prevented  by  any  system 
of  banking  legislation :  for  they  have  occurred  in  every 
country  of  the  world,  and  will  no  doubt  occur  in  this  country 
and  elsewhere  in  the  future.  Financial  panics,  however, 
can  to  a  large  degree  be  prevented,  or  at  any  rate  their 
effects  can  be  greatly  minimized.  Of  the  six  panics  which 
have  afflicted  this  country  in  the  last  half  centurv^  the  great 
majority  have  been  financial  convulsions,  which  did  not 
spring  from  any  inherent  unsoundness  in  business,  but  were 
the  results  of  defects  in  our  banking  system  and  the  unwise 
policies  which  had  been  pursued  as  a  result  of  them..' 
{  The  panic  of  1907  really  laid  the  basis  for  the  Federal 


DEFECTS  OF  PRESENT  BANKING  SYSTEM      5 

Reserve  Act  of  1913.  This  great  convulsion,  from  which 
the  country  has  not  yet  fully  recovered,  \va.s  not  the  fault 
of  business  men,  but  was  the  result  of  unwise  management  of 
banking  affaii-s.  It  was  almost  entirely  a  bankers'  panic, 
and  to  a  large  degree  the  price  has  been  paid,  in  the  inter- 
vening months,  not  by  the  bankers  but  by  business  men  and 
every  one  of  their  employees  down  to  the  humblest  workman. 
Every  individual  in  this  country  has  au  interest  in  any  plan 
of  banking  reform  that  will  to  a  large  degree  eliminate  the 
financial  disturbances  that  bring  business  disorganization 
and  dull  times. 

What  are  the  most  serious  defects  in  the  banking  system 
of  this  country?  It  is  inexpedient  at  this  time  even  to  cata- 
logue all  of  the  defects  which  exist.  Many  of  them  are 
of  minor  importance  to  the  business  man  and  to  most 
bankers.  It  is  generally  agreed  among  bankers  that  if  a  few 
serious  and  inherent  defects  could  be  remedied,  the  balance 
would  either  rectify  themselves  or  could  be  adjusted  by 
the  bankers  without  any  difficulty.  Because  there  are  so 
few  congenital  defects  it  is  wise,  as  Congress  has  done,  to 
preserve  the  old  system,  modifying  it  as  little  as  possible. 

Our  Decentralized  Reserves. — The  most  serious  defect 
is  in  the  cash  reserves  which  are  kept  by  our  banks  against 
their  deposits.  Every  bank  in  the  world  must  keep  a  cer- 
tain amount  of  cash  on  hand,  in  order  to  meet  the  demands 
of  its  depositors  and  inspire  the  confidence  of  its  customers. 
Ther  amount  which  a  bank  should  have  must  bear  some  pro- 
portion to  the  deposits  which  it  has  received.  It  should  be 
fixed  with  regard  to  the  character  of  the  deposits,  that  is, 
with  reference  to  the  type  of  people  who  are  depositors,  and 
the  purpose  which  these  people  had  in  mind  in  making  the 
deposits.  A  bank  whose  depositors  are  made  up  of  for- 
eigners who  can  not  read  English  or  who  do  not  understand 
the  customs  of  the  country,  would  need  a  larger  reserve  than 
an  institution  dealing  with  less  excitable  people,  whose  sus- 
picions would  not  be  so  readily  aroused  and  who  would  not 
be  so  likely  to  make  a  sudden  demand  for  their  money. 
A  bank  holding  the  savings  deposits  of  an  industrial  com- 


6  OPERATION  OF  THE  NEW  BANK  ACT 

munity,  representing  the  sums  laid  aside  by  workmen  and 
mechanics  as  a  provision  for  old  age,  does  not  require  as 
large  reserves  as  another  institution,  whose  accounts  consist 
largely  of  balances  intended  for  the  payment  of  the  ordinary 
debts  of  its  customers.  There  is  no  golden  rule  as  to  what 
reserve  a  bank  should  keep.  The  law  in  America  specifies 
for  every  class  of  institution,  except  private  banks,  a  certain 
minimum  amount  which  each  must  have  on  hand ;  but  the 
law,  if  wisely  drawn,  simply  reflects  the  result  of  experience 
and  the  sentiment  of  the  community. 

Unlike  the  conditions  in  Europe  or  in  Canada,  we  have 
in  this  country  an  extreme  decentralization  of  reserves, 
the  twenty-five  thousand  independent  banks  each  keeping 
a  part  of  its  reserve  in  its  own  vaults.  There  has  been  little 
concentration  of  money  in  any  one  great  reservoir  or  chain 
of  reservoirs  with  which  to  meet  the  needs  of  the  business 
institutions  or  the  banks  of  a  community  in  time  of  stress. 
The  great  central  banks  of  Europe  are  primarily  bankers' 
banks.  They  are  institutions  to  which  the  other  banks  when 
hard  pressed  can  turn  for  loans,  secured  through  the  sale 
or  rediscount  of  the  commercial  paper  which  these  banks 
have  purchased.  A  bank  in  the  United  States  has  no  such 
haven  of  refuge.  So  long  as  its  cash  reserve  holds  out  it 
can  meet  the  demands  of  its  depositors,  but  when  this  is 
gone  the  only  recourse  is  to  appeal  for  help  to  the  other 
banks  of  the  community.  These  neighbors  may  feel  that 
to  extend  help  is  dangerous,  since  by  giving  it  they  might 
weaken  themselves,  and  the  trouble  would  thus  be  spread. 
Yet  if  help  is  denied,  the  bank  under  attack  almost  inevi- 
tably fails,  and  the  crash  so  alarms  the  community  as  to 
extend  the  panic  to  other  institutions  and  create  a  most  acute 
situation. 

Aid  in  Distress. — To  the  credit  of  the  American  bankers, 
it  may  be  said  that  they  have  been  (as  a  general  rule) 
ready  to  come  to  the  aid  of  their  distressed  associates,  not 
only  through  patriotic  motives  but  because  self-interest  has 
prompted  it.  In  some  cases  aid  is  extended  by  an  unusually 
strong  bank  which  puts  its  credit  behind  the  weaker  institu- 


DEFECTS  OF  PRESENT  BANKING  SYSTEM      7 

tion,  restores  confidence,  and  stops  the  run.  In  other  cases 
the  banks,  through  a  cooperative  organization  known  as 
a  clearing  house,  originally  designed  for  the  purpose  of 
exchanging  checks  between  banks  which  are  its  members, 
accomplishes  the  desired  end.  The  assistance  given  is 
through  loans  made  by  the  clearing  house,  the  member 
banks  contributing  to  the  organization  such  amounts  as  they 
feel  they  can  spare,  or  as  they  may  be  called  upon  by  the 
clearing  house  association  to  furnish.  These  devices  are, 
at  the  best,  only  makeshifts.  Fear  can  not  be  quelled  as  long 
as  there  is  any  possibility  that  aid  will  not  be  forthcoming 
promptly,  and  to  an  extent  sufficient  to  prevent  disaster. 
The  bitter  experience  of  six  panics  has  ingrained  in  the 
American  people  a  more  or  less  unconscious  distrust  of  the 
emergency  measures  which  banks  can  take,  and  no  matter 
how  willing  may  be  the  financial  institutions  to  aid  each 
other,  this  popular  suspicion  practically  nullifies  in  advance 
every  effort. 

Deposit  Reserves. — It  should  not  be  inferred  that  all 
of  the  twenty-five  thousand  banks  in  this  country  carry 
their  reserves  in  their  own  vaults.  Such  a  system  of 
decentralization  does  not  exist  in  any  civilized  country.  To 
a  certain  degree  there  is  centralization.  A  large  proportion 
of  the  State  banks  carry  a  part  of  their  reserves  on  deposit 
with  other  State  banks  or  with  national  banks.  The  national 
banks  are  divided  into  three  classes,  the  banks  in  all  but 
one  of  which  are  allowed  to  carry  a  portion  of  their  reserve 
on  deposit  with  lianks  in  the  other  classes.  Thus  a  peculiar 
situation  is  developed.  A  large  share  of  the  resources  of  the 
big  banks  of  our  large  cities  represents  the  funds  deposited 
by  smaller  banking  institutions  scattered  over  a  wide  area. 
These  funds  are  a  part  of  the  cash  reserve  of  the  scattered 
banks.  This  situation  exists  to  a  peculiar  extent  in  New 
York  City  and  in  Chicago.  At  the  time  of  the  panic  of  1907 
over  i};4fi5,000,00n  of  the  i|;l. 000.000,000  of  the  deposits  of  the 
national  banks  of  Now  York  City  wore  the  reserves  of  other 
banks  of  tbe  country,  wliieli  had  been  deposited  with  them. 
Tl^e  panic  of  1907  began  as  a  small  local  disturbance  in  New 


8  OPERATION  OF  THE  NEW  BANK  ACT 

York  City.  For  various  reasons  it  was  not  suppressed  in 
time  and  gradually  involved  other  institutions  in  the  metrop- 
olis. Before  any  one  realized  it,  a  lurid  exposure  of  the 
malodorous  practices  of  a  certain  group  of  financiers  who 
controlled  some  of  the  New  York  institutions  filled  the  news 
columns  of  practically  eveiy  paper  in  the  United  States. 
Bankers  and  the  public  at  large  began  to  be  distrustful  of 
the  whole  New  York  banking  fabric.  The  banks,  anticipat- 
ing trouble,  started  to  call  home  a  part  of  their  reserves,  and 
a  national  panic  was  on. 

New  York  Reserves  Small, — A  great  defect  of  our 
system  became  at  once  glaringly  apparent.  The  big  banks  of 
New  York  have  never  carried  a  large  surplus  reserve  to 
meet  such  demands  from  out-of-town  banks,  and  when 
the  demands  were  made  a  suspension  of  the  New  York 
banks  was  inevitable.  The  same  thing  had  occurred  over 
and  over  again  under  similar  circumstances.  The  New 
York  institutions  were  not  able  to  pay  back  any  considerable 
percentage  of  their  $465,000,000  of  bankers'  deposits.  To 
handle  the  demand  of  their  own  local  customers  it  became 
necessary  for  them  to  suspend  cash  payments  entirely,  by 
refusing  to  cash  cheeks  over  the  counter;  and  to  prevent 
withdrawals  through  the  clearing  house  by  the  device  of  the 
clearing  house  loan  certificate.  These  devices  were  extra- 
legal, but  enabled  the  New  York  banks  to  evade  paying 
many  of  their  creditors.  The  clearing  house  loan  certifi- 
cate is  a  receipt  acknowledging  the  deposit  with  the  clearing 
house  association  of  approved  collateral  to  an  amount  suffi- 
cient to  warrant  the  issue  of  the  certificate.  The  certificate 
must  be  accepted  at  its  face  by  any  bank  in  the  clearing 
house  in  settlement  of  balances  due. 

When  the  New  York  banks  issue  clearing  house  loan 
certificates,  suspension  of  cash  pajTuents  throughout  the 
countr}^  immediately  follows.  Eveiy  banker  realizes  that 
if  the  New  York  banks  can  not  pay  each  other,  they  can  not 
pay  him ;  and  the  banks  in  every  state  from  Florida  to  Ore- 
gon and  from  Maine  to  California  immediately  follow  suit 
by  hoarding  cash.    In  a  flash  the  ordinary  methods  of  pay- 


DEFECTS  OF  PRESENT  BANKING  SYSTEM      9 

ment  are  destroyed,  and  business,  when  done  at  all,  must  be 
entirely  upon  the  basis  of  future  payments. 

This  is  the  story  of  the  panic  of  1907  and  it  is  typical 
of  what  has  occurred  in  every  other  great  panic  in  the  last 
half  century.  There  were  no  conditions  which  would  cause  a 
panic  in  Minnesota,  in  the  Middle  West,  in  the  South,  in 
New  England,  or  in  any  part  of  the  countiy  except  New 
York  City.  The  failure  of  the  New  York  banks  to  meet 
their  obligations  while  they  were  holding  a  large  part  of  the 
reserves  of  the  country  banks,  had  the  same  effect  upon 
the  circulation  of  money  as  the  failure  of  the  heart  beat 
upon  the  circulation  of  the  blood.  Anj^  refonn  in  our 
system  of  banking  which  will  not  so  alter  conditions  as  to 
prevent  such  a  disturbance  will  fail  of  its  purpose. 

Weaknesses  in  This  Practice. — If  centralization  of  bank 
reserves  is  the  universal  rule  in  European  countries,  where 
panics  are  less  frequent,  why  is  it  that  the  centralization  of 
bank  reserves  in  the  institutions  of  New  York  City  and 
elsewhere  is  so  dangerous?  The  reason  for  the  failure  in 
this  feature  of  our  system  is  the  absence  of  a  central  reser- 
voir, or  a  series  of  regional  reservoirs  of  money,  from  which 
the  banks  may  draw  freely  in  time  of  need.  The  central 
or  regional  banks,  if  we  can  judge  from  European  experi- 
ence, would  meet  the  difficulty  which  periodically  exists  in 
this  country  by  enabling  the  banks  in  New  York,  or  in  any 
other  district  where  a  large  demand  for  money  exists,  to 
sell  a  part  of  their  assets  in  exchange  for  cash  with  which 
to  meet  the  needs  of  their  bank  and  individual  depositors. 
The  function  of  a  central  banking  institution  is  primarily 
to  enable  the  other  banks  of  the  country  to  convert  their 
assets  into  money.  A  bank  can  not  prevent  a  panic  by  show- 
ing its  depositors  the  fine  line  of  commercial  paper  or  col- 
lateral loans  in  which  it  has  invested  the  depositors'  money .^ 
The  only  thing  which  will  bring  a  sense  of  security  and  stop 
withdrawals  is  the  development  of  a  feeling  of  assurance 
that  the  bank  can  meet  the  claims  of  any  and  all  depositors. 

]\Iost  of  our  banking  institutions  receive  deposits  subject 
to  repayment  upon  demand.    In  ordinary  times  they  know 


10        OPERATION  OF  THE  NEW  BANK  ACT 

about  what  these  demands  will  average  from  day  to  day, 
and  a  sufficient  amount  of  cash  is  kept  on  deposit  with  some 
other  bank  from  which  it  may  be  immediately  secured.  The 
balance  can  be  invested,  A  bank  can  not  earn  dividends  by 
keeping  the  funds  of  its  depositors  lying  idle  in  its  vaults. 
The  great  problem  of  banking  is  to  find  investments  which 
will  keep  these  funds  liquid,  so  that  they  can  be  converted 
or,  better  still,  will  convert  themselves  into  money  at  short 
intervals.  In  general,  the  plan  of  investment  followed  by  a 
bank  is  to  keep  a  certain  amount  of  cash,  as  we  have  said, 
on  hand  or  on  deposit  with  some  other  banking  institution. 
This  is  known  as  its  primary  reserve.  In  addition  to  this 
it  will  make  demand  loans  upon  collateral,  which,  when 
called,  will  theoretically  enable  the  bank  to  replenish  its 
stock  of  cash  by  the  aggregate  of  such  items. 

Mobilization  of  Reserves. — These  two  general  classes 
of  resources,  however,  make  up  the  smaller  part  of  the 
assets  of  our  banking  institutions.  The  major  portion  of  a 
bank's  capital  and  of  the  funds  of  the  depositors  is  in- 
vested in  short  time  commercial  paper,  maturing  in  not 
to  exceed  four  months;  in  high  grade  bonds  (preferably 
listed)  which,  because  of  a  wide  market,  can  be  turned  into 
cash  upon  short  notice ;  and  other  securities  of  a  less  liquid 
character.  Speaking  generally,  the  greater  proportion  of 
a  bank's  assets  can  not,  by  the  terms  of  the  contract  between 
the  bank  and  its  customers,  be  converted  into  money  in  less 
time  than  from  thirty  to  sixty  days.  Unless  the  average 
bank  can  either  borrow  against  its  assets  or  sell  them  to  some 
other  institution,  it  will  be  forced  to  close  its  doors  if  a 
serious  run  occurs.  The  function  of  a  central  bank  is  to 
prevent  this.  If  a  bank  or  a  number  of  banks  are  hard 
pressed,  they  go  to  the  central  institution  and  either  sell 
a  part  of  their  assets  or  borrow  against  them,  the  central 
bank  giving  them  money  or  a  credit  on  its  books  as  they 
may  elect,  for  the  aggregate  amount  of  the  sale  or  loan. 
The  central  bank  in  performing  this  service  uses  the  funds 
which  have  been  deposited  with  it  by  the  other  tributary 
banlcs,  representing  a  portion  of  the  cash  reserve  of  these 


DEFECTS  OF  PRESENT  BANKING  SYSTEM    11 

institutions.  This  is  what  is  meant  by  the  mobilization 
of  reserves.  )  If  a  run  should  occur  upon  every  bank  in  the 
country  at  the  same  time,  the  failure  of  all  would  be  inevi- 
table, but  this  situation  never  liappens.  Fires  tlo  not  start 
simultaneously  in  every  house  in  the  city.  The  funds  wliich 
the  unmolested  banl<s  have  on  deposit  with  the  central  in- 
stitution are  used  by  it  to  help  those  under  pressure,  and, 
what  is  of  even  greater  importance,  these  banks  in  most  of 
the  foreign  countries  have  the  ability  to  issue  bank  notes  to 
such  an  amount  as  may  be  necessary  to  meet  any  sudden 
and  unreasoning  demand  for  money,  thus  elfectually  ending 
the  panic  by  enabling  the  member  banks  to  pay  off  their 
depositors  dollar  for  dollar. 

As  Mr.  Andrew  J.  Frame,  one  of  the  leading  bankers  of 
the  Northwest,  phrased  it,  ' '  We  obtain  restoration  of  confi- 
dence in  the  United  States  after  we  have  had  trouble,  and 
after  the  wheels  of  commerce  are  stopped.  What  we  want 
to  do  is  to  keep  the  wheels  of  commerce  ni  motion,  and  by 
having  some  great  reservoir  of  cash  we  can  accomplish  it. 
I  care  not  what  that  method  may  be,  providing  we  charge 
a  sufficiently  high  rate  of  interest  so  that  extra  cash  will 
come  out  in  the  day  of  trouble.  I  do  not  care  if  a  charge 
of  eight  per  cent  is  made  for  it,  but  that  we  can  get  relief 
so  that  we  do  not  suspend  cash  payments.  Within  sixty 
or  ninety  days  after  the  panic  stops,  I  never  knew  the  time 
yet  that  our  depositors  did  not  come  back  with  their  cash. 
Then  when  it  does  come  in,  we  have  a  plethora  of  money 
and  are  ready  to  pay  back  what  we  have  borrowed  from  the 
reservoir  that  furnished  us  the  cash ;  we  take  our  securities 
back  home,  normal  conditions  are  resumed  and  running 
smoothly  as  before.  Now,  really,  that  is  the  whole  thing 
in  a  nutshell,  as  I  see  it." 

Hoarding  in  Panics. — In  many  ways  Mr.  Frame  is  right 
when  he  attributes  most  of  the  defects  of  our  banking  system 
to  bank  reserves.''  However,  a  great  majority  of  bankers 
and  students  of  the  banking  question  would  hardly  agree 
that  this  is  the  only  defect.  There  are  certain  collateral 
difficulties  which  arise  out  of  the  system  of  rigid  reserves. 


12        OPERATION  OF  THE  NEW  BANK  ACT 

One  of  the  most  serious  of  these  is  that  when  there  is  a 
general  tightening  of  credit  and  financial  conditions  look 
dubious,  many  persons  begin  to  draw  money  from  the 
banks,  hoarding  it  at  home  or  in  a  safe  deposit  vault,  be- 
cause they  fear  a  suspension  of  cash  payments.  This 
weakens  the  position  of  the  banks,  because  the  more  cash 
they  pay  out,  the  smaller  is  their  ability  to  extend  credit; 
and  hence  they  are  forced  to  accentuate  the  trouble  by  cur- 
tailing loans.  As  soon  as  this  tendency  becomes  apparent 
every  bank  inaugurates  steps  to  strengthen  its  reserve. 
Money  is  called  from  reserve  agents,  repayments  of  call 
loans  are  demanded  and  steps  are  taken  to  put  each  bank 
in  position  to  withstand  a  financial  storm.  The  calling  of 
loans  forces  merchants  and  speculators  in  merchandise  and 
securities  to  sell  their  holdings  at  the  best  prices  obtainable, 
in  order  to  secure  the  necessary  funds,  since  they  now  find 
it  impossible  to  shift  their  loans  from  one  bank  to  another. 
The  drop  in  prices  which  follows  further  alanns  the  business 
community,  undermining  confidence,  lowering  the  value  of 
the  collateral  behind  loans,  and  in  other  ways  aggravating 
the  situation  and  hastening  a  crisis. 

Free  Lending  Impossible. — Experience  has  shown  that 
this  vicious  cycle  can  be  destro^^ed  only  by  liberal  lending 
on  the  part  of  the  banking  institutions.  This  tends  to  check 
the  alarm,  avoids  the  necessity  of  ruinous  sacrifices  and 
restores  normal  business  conditions.  Yet  such  a  policy  is 
impossible  when  the  bank's  ability  to  lend  is  being  con- 
stantly curtailed  by  the  reduction  of  its  cash  reserves. 

The  Money  We  Use. — In  the  past,  emphasis  has  been 
laid  upon  our  system  of  money  as  one  of  the  chief  causes 
of  the  weakness  in  our  banking  system.  It  is  now  generally 
recognized  that  our  difficulties  are  more  largely  ones  of 
credit  than  of  money.  'To  a  certain  extent,  however,  our 
money  is  one  of  the  weaknesses  in  our  financial  system. 
The  money  which  we  use  in  this  country  can  be  divided 
roughly  into  two  main  classes:  first,  that  put  out  by  the 
government,  and  second,  that  issued  by  the  national  banks, 
in  which  the  liabilitv  of  the  government  is  secondary.    The 


DEFECTS  OF  PRESENT  BANKING  SYSTEM    13 

money  issued  by  the  governmeut  may  be  divided  into  two 
general  classes — gold  and  promises  to  pay  gold. 

i  Gold  coin  does  not  need  the  stamp  of  the  government 
upon  it  to  give  it  value.  The  purchasing  power  of  gold  coin 
is  determined  by  the  worth  of  the  metal  contained  in  it, 
and  the  stamp  of  the  nation  which  has  coined  it  is  simply 
a  guarantee  that  the  metal  is  of  a  certain  degree  of  fineness 
and  the  coin  of  a  definite  weight.  Very  little  actual  gold 
coin  is  in  circulation.  A  large  part  of  it  is  to  be  found 
either  in  the  vaults  of  the  Treasury,  where  it  is  used  to  sup- 
port and  give  value  to  the  government's  promises  to  pay 
gold,  or  in  the  vaults  of  the  banks.  Also  a  large  part  circu- 
lates as  gold  certificates  or  "yellow  backs,"  which  are  ware- 
house receipts  issued  by  the  United  States  government 
certifying  that  it  has  on  hand  an  equivalent  number  of 
gold  dollars,  for  which  the  receipt  may  be  redeemed  at 
any  time.  In  addition  to  the  gold  and  gold  certificates  the 
government  has  outstanding  a  considerable  amount  of  money 
which  has  value  largely  because  of  the  good  faith  and  credit 
of  the  United  States.  This  class  of  money  includes  silver 
dollars,  silver  certificates,  United  States  notes,  or  greenbacks, 
and  the  subsidiary  coin. 

^  Our  Token  Money. — The  metal  contained  in  the  stand- 
ard silver  dollar  is  at  present  worth  about  fifty  cents.  The 
silver  certificate  is  but  a  warehouse  receipt  for  a  silver  dollar, 
and,  of  course,  can  have  no  greater  value  than  that  coin. 
The  silver  dollar,  however,  is  taken  at  its  face  value  the 
country  over  because  of  the  fact  that  the  United  States  has 
stood  willing  for  many  years  to  redeem  it,  or  the  silver  certifi- 
cate, in  gold.  The  silver  dollar  thus  stands  midway  between 
gold  coin  and  the  greenback.  The  latter  has  no  intrinsic 
value,  and  gets  its  entire  purchasing  power  because  of  the 
good  faith  and  credit  of  the  government,  supported  by  the 
reserve  of  $150,000,000  in  gold.  The  United  States  note  or 
greenback  is  merely  a  promise  on  the  part  of  the  United 
States  government  to  pay  to  the  bearer  on  demand  a  stated 
number  of  dollars.  While  the  government  could  have 
selected  any  sort  of  dollar  with  which  to  keep  this  obli- 


14        OPERATION  OF  THE  NEW  BANK  ACT 

gation,  the  United  States  is  now  definitely  pledged  to  re- 
deem these  notes  upon  demand  in  gold.  In  order  to  show 
good  faith  and  to  demonstrate  to  the  world  an  ability  to 
keep  its  promises,  the  Treasury  Department  is  required 
to  keep  on  hand  $150,000,000  in  gold  coin  primarily  for  the 
purpose  of  redeeming  some  $346,000,000  of  United  States 
notes,  but  also  to  protect  $490,000,000  of  silver  certificates, 
$74,000,000  of  silver  dollars  and  $178,000,000  of  subsidiary 
coin. 

Suggestions  were  made  from  some  quarters  that  the 
Federal  Reserve  Act  should  carry  a  provision  which  would 
retire  the  United  States  notes  or  greenbacks,  which  were 
alleged  to  be  a  source  of  possible  future  trouble.  The 
great  majority  of  bankers,  however,  who  appeared  before 
the  Congressional  committees  when  the  Federal  Reserve 
Act  was  under  consideration,  did  not  share  this  view,  hold- 
ing that  at  the  present  time  no  difficulty  need  be  expected 
from  these  notes. 

Elasticity  Lacking. — There  is  no  elasticity  in  the  money 
coined  and  issued  by  the  United  States  government  from 
year  to  year,  except  in  the  amount  of  gold  coin.  A  definite 
limitation  has  been  placed  upon  the  issue  of  United  States 
notes,  silver  dollars  and  silver  certificates.  Unless  the 
amount  of  gold  coin  is  increased  or  decreased — a  thing 
difficult  to  accomplish  quickly  or  on  a  large  scale — there  is 
no  way  in  which  an  increased  fund  of  money  can  be  quickly 
provided  to  meet  the  needs  of  the  country.  The  only  fonn 
of  money  in  the  United  States  which  fluctuates  to  any  degree 
in  volume  is  the  national  bank  note. 

National  Bank  Notes. — A  national  bank  note  is  the 
direct  obligation  of  a  national  bank  which  issues  it  and 
which  promises  to  redeem  it  on  demand  in  lawful  money. 
The  notes  are  secured  by  a  deposit  by  the  issuing  bank  with 
the  Treasurer  of  the  United  States,  of  an  amount  of  govern- 
ment bonds  equal  in  face  value  to  the  amount  of  notes 
issued.  These  bonds  are  held  by  the  government  as  col- 
lateral security,  and  in  the  event  of  the  failure  of  the  bank 
to  redeem  these  notes,  the  bonds  are  sold  and  the  proceeds 


DEFECTS  OF  PRESENT  BANKING  SYSTEM    15 

used  for  this  purpose.  The  national  bank  notes  are  pro- 
tected in  other  ways,  one  of  which  is  the  redemption  fund — 
a  sum  of  money  in  the  Treasury  at  Washington  equal  to 
five  per  cent  of  the  notes  outstanding.  This  is  used  for 
the  purpose  of  redeeming  such  notes  as  may  be  forwarded 
for  redemption  by  other  banks  to  the  Treasury  Department. 
The  notes  are  also  a  first  lien  upon  the  assets  of  the  bank 
and  upon  the  liability  of  the  stockholders  thereof  for  debts 
of  the  institution. 

^  There  has  never  been  any  loss  to  holders  of  national  bank 
notes.  Whatever  objection  is  made  to  them  does  not  con- 
cern their  safety.  The  profits  of  a  bank  issuing  these  notes 
are  exceedingly  small,  amounting,  according  to  the  Comp- 
troller of  the  Currency,  to  about  1.2  per  cent  per  annum, 
providing  the  notes  are  kept  in  circulation  all  of  the  time. 
With  such  a  small  margin  of  profit  it  has  been  difficult  to  get 
the  banks  to  issue  the  notes  in  a  quantity  sufficient  to  give 
an  ade(iuate  circulating  medium  in  times  of  great  industrial 
activity.  What  is  even  worse,  the  expense  and  trouble  inci- 
dent to  their  retirement  discourage  the  banks  from  taking 
steps  to  retire  a  part  of  their  circulation ;  with  the  result 
that  when  business  slackens,  and  the  demand  for  money  has 
correspondingly  decreased,  these  notes  are  not  retired,  but 
pile  up  in  the  vaults  of  the  bank.  To  be  exact,  they  gener- 
ally pile  up  in  the  vaults  of  the  State  banks  and  trust 
companies,  which  can  count  them  as  a  part  of  their  cash 
reserve.  A  national  bank  can  not  count  either  its  own  notes, 
which  are  its  liabilities,  or  the  notes  of  any  other  national 
bank  as  a  part  of  its  cash  reserve. 

This  has  proved  a  source  of  weakness  in  the  past,  for 
it  has  been  impossible  for  the  national  banks  to  strengthen 
their  cash  reserves  in  times  of  great  industrial  prosperity 
through  the  issue  of  these  notes.  While  the  national  banks 
can  not  count  national  l)ank  notes  as  part  of  their  reserve, 
yet  they  are  of  value  to  them  in  times  of  stress,  because  thoy 
can  be  paid  out  over  the  counter,  satisfying  the  demands  for 
cash,  the  lawful  money  being  retained  in  the  bank's  vaults 
as  its  reserve.     Primarilv  bank  notes  should  be  issued  for 


16    OPERATION  OF  THE  NEW  BANK  ACT 

circulation  in  the  hands  of  the  public,  and  this  theory  has 
been  followed  in  the  drafting  of  the  Federal  Reserve  Act. 

Bank  Note  Elasticity  Insufficient. — Experience,  par- 
ticularly in  the  panic  of  1907,  has  shown,  however,  that 
the  mere  issue  of  bank  notes  will  not  solve  the  problem. 
The  difficulty  is  only  in  part  a  lack  of  currency  in  the  hands 
of  the  public.  What  is  much  more  important  is  the  crea- 
tion of  some  means  by  which  the  lending  power  of  the  banks 
can  be  increased  at  critical  times.  An  ideal  system  of 
money  is  one  which  will  expand  as  the  needs  of  business 
require  an  additional  supply,  and  which  will  automatically 
contract  when  this  additional  need  is  over.  It  is  not  suffi- 
cient to  provide  for  expansion,  because  unless  a  sure  method 
of  contraction  is  included,  disaster  will  surely  follow.  The 
amount  of  money  in  circulation  must  bear  a  relation  to  the 
volume  of  business  which  is  then  to  be  financed.  Our  supply 
of  money  in  the  past  has  had  no  direct  relation  to  business 
whatever.  Unlike  the  monetary  system  of  Canada,  where 
the  notes  of  the  banks  expand  and  contract  in  amount  auto- 
matically with  the  ebb  and  flow  of  business,  we  have  just  as 
much  money  in  the  dull  times  of  the  year  as  we  have  in  the 
periods  of  greatest  activity.  The  result  has  been  that  we 
have  a  plethora  of  money  in  the  dull  months  and  a  currency 
famine  in  the  most  active  periods. 

Lack  of  Central  Control. — One  of  the  most  serious  de- 
fects in  our  banking  system  is  the  absence  of  any  strong, 
quieting  hand  which  can  enforce  united  action  by  the  banks 
along  intelligent  lines.  There  has  been  no  power  in  the 
United  States  to  control  the  aggregate  expansion  of  bank 
credits  with  relation  to  the  aggregate  amount  of  bank  re- 
serves. Credits  are  allowed  to  expand  without  any  thought 
being  taken  of  the  reserve  which  must  carry  them,  until  we 
reach  a  top-heavy  condition  where  a  crash  is  inevitable. 
This  expansion  encourages  speculation,  the  over-extension 
of  business  operations,  and  an  unhealthy  condition  in  our 
security  markets.  The  absence  of  any  central  authority 
results  in  no  provision  being  made  for  those  times  when  an 
exceptional  amount  of  currency  is  needed  for  circulation 


DEFECTS  OF  PRESENT  BANKING  SYSTEM    17 

among  the  people,  or  wlieu  an  exceptional  amount  of  credit 
is  needed  to  take  care  of  the  business  of  the  country.  We 
rush  blindlj'  along,  no  bank  taking  a  national  view,  but  each 
interested  solely  in  its  individual  profits,  until  the  rope 
of  credit  is  stretched  to  the  limit  of  its  strength.  When  the 
slightest  unusual  strain  comes,  a  break  is  inevitable. 

We  have  here  the  four  most  important  defects  in  our 
banking  system — decentralized  reserves,  immobilized  com- 
mercial paper,  inelastic  note  issues,  and  the  absence  of  a 
central  controlling  authority.  Many  others  might  be  stated 
and  explained,  such  as  the  hoarding  of  money  in  our  inde- 
pendent treasury  system,  the  absence  of  any  central  author- 
ity which  will  protect  the  gold  reserves  of  the  country,  the 
inability  of  our  banks  to  finance  foreign  trade  upon  as 
favorable  a  basis  as  that  abroad,  the  lack  of  any  public 
discount  market  where  commercial  paper  can  be  sold  under 
the  most  favorable  conditions  and  at  lower  rates  than  we 
have  ever  enjoyed,  and  many  other  important  matters  of 
a  similar  character.  Each  of  these  defects  in  our  banking 
and  currency  system,  however,  will  be  taken  up  and  analyzed 
in  conjunction  with  the  provisions  of  the  Federal  Reserve 
Act  which  aim  to  correct  them.  All  that  we  need  do  at  the 
present  time  is  to  secure  a  general  view  of  the  problem  which 
confronts  the  country  and  which  the  Federal  Reserve  Act 
attempts  to  solve.  The  fault  is  not  one  inherent  in  our 
method  of  banking.  It  has  not  arisen  from  mismanagement 
of  our  banking  institutions.  It  is  due  to  the  absence  of 
certain  features  in  our  banking  system  which  are  found 
in  the  systems  of  other  countries  of  the  world.  Instead  of 
destroying  what  we  have,  there  should  be  erected  upon  it  a 
superstructure,  which  will  enable  the  banks  to  handle  the 
problems  with  which  they  have  heretofore  unsuccessfully 
struggled.  Reform  has  very  properly  been  not  destruction, 
but  construction  on  the  basis  of  that  which  has  proven  good 
and  which  has  been  of  such  great  value  in  the  upbuilding  of 
this  country  in  the  last  fifty  years. 


CHAPTER  II 

The  New  Law  Summarized 

Earlier  Legislation. — The  need  of  a  general  revision 
of  our  currency  and  banking  laws  has  been  felt  for  years, 
and  minor  changes  have,  from  time  to  time,  been  made. 
Among  the  most  recent  was  the  Currency  Act  of  JMarch  14, 
1900,  which  was  an  attempt  to  lessen  the  dangers  that  lurked 
in  the  greenbacks,  the  Treasury  Notes  of  1890,  and  the  silver 
dollars.  No  matter  how  much  its  provisions  may  have  added 
to  the  safety  of  our  money  supply,  there  was  still  no  elas- 
ticity ;  and  after  the  panic  of  1907  another  effort  at  im- 
provement was  made.  The  result  was  a  temporary  measure 
—the  Aldrich-Vreeland  Act  of  May  30,  1908.  Under  its 
provisions  the  national  banks  may  organize  themselves  into 
National  Currency  Associations.  A  member  bank,  if  it 
already  has  outstanding  a  circulation  secured  by  United 
States  bonds  equal  to  forty  per  cent  of  its  capital,  is  allowed 
to  extend  its  note  issues  upon  other  classes  of  securities, 
until  the  total  is  equal  to  the  sum  of  its  capital  and  surplus. 
The  additional  notes  are  subject  to  a  tax  which  is  relied 
upon  to  force  their  retirement. 

Objections  to  the  Aldrich-Vreeland  Act. — This  Act 
was  intended  to  be  only  an  emergency  measure  and  was  to 
expire  by  limitation  on  June  30,  1914.  For  a  time  the  banks 
hesitated  to  form  the  currency  associations;  but  after  the 
Secretary  of  the  Treasury  gave  a  somewhat  generous  inter- 
pretation to  some  of  the  doubtful  points  and  strongly  urged 
the  importance  of  action,  a  number  were  formed.  The 
$500,000,000  of  notes  (the  maximum  total  issue  possible) 
were  printed  and  placed  in  the  various  United  States  sub- 
treasuries  for  use  when  needed.  Thus  far  they  have  not 
been  used.  The  delay  incident  to  securing  the  notes,  the 
necessity  for  a  bank  to  reveal  to  the  other  members  of  the 
currency  association  its  need  for  an  emergency  issue,  the 
18 


THE  NEW  LAW  SUMIVIARIZED  19 

general  inertia  of  the  banks  toward  any  new  methods,  and 
perhaps  a  lack  of  real  occasion  for  using  the  law,  have  con- 
tributed to  make  the  legislation  inoperative.  It  may,  of 
course,  be  true  that  its  mere  existence  on  the  statute  books 
has  been  of  value  in  preventing  the  development  of  panic 
conditions. 

One  of  the  sections  of  the  Aldrich-Vreeland  Act  provided 
for  the  appointment  of  the  National  IMonetary  Commission, 
composed  of  Senators  and  Repi'esentatives  in  Congress. 
This  Commission  reported  the  plan  that  has  generally  been 
known  as  the  Aldrich  Bill.  Strong  opposition  to  its  passage 
developed  and  it  was  never  acted  upon.  In  the  meantime 
the  reaction  against  the  leadership  and  policies  of  the  con- 
servative Republicans  became  so  pronounced  that  the  task 
of  reorganizing  our  monetary  and  banking  system  fell  to  the 
Democrats. 

The  Federal  Reserve  Act. — The  bill  that  became  a  law 
in  December,  1913,  was  introduced  into  the  House  of  Repre- 
sentatives on  June  26  of  the  same  year.  After  a  few  slight 
changes  in  the  Committee  on  Banking  and  Currency,  to 
which  it  was  referred,  it  was  reported  to  the  House  and 
passed.  It  promptly  appeared  in  the  Senate,  which  referred 
it  to  the  Committee  on  Banking  and  Currency,  whose  mem- 
bers found  themselves  unable  to  agree  on  a  report.  Finally 
a  decision  was  reached  to  return  to  the  Senate  the  House 
Bill  and  with  it  two  others.  One  of  them  was  endorsed  by 
the  Democratic  members  under  the  leadership  of  Senator 
Owen,  the  other  by  the  Republican  members  who  were 
joined  by  Senator  Hitchcock,  a  Democrat.  As  finally  passed 
by  the  Senate  and  later  modified  by  the  conference  com- 
mittee, the  Act  bears  more  resemblance  to  the  "Owen  " 
draft  than  to  any  of  the  others. 

Action  Not  Hasty. — Although  it  micrht  appear  that 
this  bill  bad  been  rushod  through  both  the  House  and  the 
Senate,  it  would  be  incorrect  to  a.ssume  that  the  mea.sure 
was  passed  without  adequate  consideration.  In  fact,  such 
was  not  the  ease.  The  subjeot  has  been  before  the  countrv' 
in  a  general  way  for  years.    It  had  been  discussed  both  in 


20        OPERATION  OF  THE  NEW  BANK  ACT 

Congress  and  by  the  public  at  the  time  of  the  report  of  the 
National  Monetary  Commission,  and  the  introduction  into 
Congress  by  that  body  of  the  so-called  Aldrich  Bill.  The 
Owen-Glass  Bill  itself  received  thorough  consideration. 
Hearings  on  the  subject  were  held  during  January  and 
February,  1913,  the  testimony  given  at  that  time  by  the 
witnesses  who  appeared  filling  745  printed  pages.  The 
Bill  introduced  into  the  House  of  Eepresentatives  by  Mr. 
Glass  on  June  26,  1913,  remained  under  consideration 
by  the  House  Committee  on  Banking  and  Currency  until 
September  9,  when  it  was  reported  to  the  House  and  passed 
by  it  on  September  17.  The  Senate  Committee  on  Banking 
and  Currency  had  anticipated  the  Bill's  passage  and  had 
begun  hearings  on  the  subject  on  September  2,  continuing 
them  until  November  6.  The  testimony  taken,  together  with 
the  index,  fills  three  large  volumes,  with  a  total  of  3259 
printed  pages.  In  addition  to  the  extensive  investigations 
and  reports  by  the  National  ^Monetary  Commission  and  the 
hearings  just  described,  there  was  held  in  1912  the  Pujo 
Committee's  investigation  of  the  alleged  "Money  Trust." 
There  was  thus  extensive  consideration  of  the  entire  ques- 
tion from  many  different  angles. 

The  New  Law. — By  the  provisions  of  the  Act  the 
Continental  United  States  is  to  be  divided  into  from  eight 
to  twelve  districts,  in  each  of  which  there  is  to  be  organized 
an  institution  to  be  known  as  a  Federal  reserve  bank.  The 
capital  of  each  Federal  reserve  bank  must  be  at  least 
$4,000,000  and  is  to  be  furnished  primarily  by  the  member 
banks  of  its  district.  National  banks  must  subscribe,  and 
State  banks  and  trust  companies  may  subscribe,  each  to  an 
amount  equal  to  six  per  cent  of  its  own  capital  and  surplus, 
all  subscribing  institutions  being  known  as  member  banks. 
One-half  of  the  subscription  must  be  paid  within  a  limited 
time,  the  balance  remaining  subject  to  call.  National  banks 
must  comply  with  the  provisions  of  the  Act  within  one  year 
or  forfeit  their  charters.  If  the  stock  subscriptions  by 
these  member  banks  are  inadequate,  stock  may  be  offered 
to  the  public,  and  if  then  the  amount  secured  is  insufficient, 


THE  NEW  LAW  SUMMARIZED  21 

the  balance  needed  will  be  allotted  to  the  United  States,  to 
be  paid  for  from  Treasury  funds. 

Each  of  these  reserve  banks  is  to  have  its  own  board 
of  nine  directors,  six  of  whom  are  to  be  chosen  by  the 
member  banks  and  three  appointed  by  the  Federal  Reserve 
Board.  The  Secretary  of  the  Treasury  may  order  the 
deposit  with  the  Federal  reserve  banks  of  the  general  funds 
in  the  Treasury  of  the  United  States,  They  are  to  act  as 
fiscal  agents  of  the  United  States  government.  The  Secre- 
tary of  the  Treasury  may  also  use"  member  banks  as  deposi- 
taries, but  may  not  use  any  banks  not  members  of  the  sys- 
tem for  this  purpose.  Reserve  requirements  of  banks  join- 
ing the  system  are  lowered.  A  part  of  the  reserves  they  are 
required  to  keep  must  be  on  deposit  with  the  reserve  banks, 
a  part  must  be  in  their  own  vaults,  and  the  balance  must 
be  with  the  reserve  banks,  in  their  own  vaults,  or  both. 
Earnings  of  the  reserve  banks  are  to  be  divided  between 
member  banks,  a  surplus  fund  for  the  reserve  bank,  and  a 
franchise  tax  to  the  United  States.  Branches  may  be  estab- 
lished within  its  district  by  any  Federal  reserve  bank. 

The  Reserve  Banks, — The  chief  work  of  the  reserve 
banks  will  be  the  rediscounting  of  commercial  paper.  A 
member  bank  may  replenish  its  reserves  when  it  wishes 
by  taking  to  the  reserve  bank  of  its  district  any  commercial 
paper  whose  date  of  maturity  at  the  time  is  not  more  than 
ninety  days  distant.  There  are  stipulations  also  with  regard 
to  the  discount  of  a  limited  kind  and  amount  of  paper  with  a 
maturity  not  exceeding  one  hundred  and  eighty  days.  The 
reserve  bank  is  empowered  to  advance  funds  on  this  paper, 
or  in  other  words  to  "rediscount"  it,  at  a  rate  subject  to 
review  and  determination  by  the  Federal  Reserve  Board. 

Organization  and  Control. — The  Secretary  of  the 
Treasury,  the  Secretary  of  Agriculture,  and  the  Comptroller 
of  tha  Currency  are  to  act  as  "The  Reserve  Bank  Organiza- 
tion Committee,"  whose  duty  it  shall  be  to  detei-mine  upon 
the  districts  and  to  supervise  the  organization  of  the  reserve 
banks.  The  Federal  Reserve  Board,  which  succeeds  the 
Organization  Committee,  has  sweeping  powers  of  super- 


22         OPERATION  OF  THE  NEW  BANK  ACT 

vision  and  control.  This  Federal  Reserve  Board  is  to  be 
composed  of  the  Secretary  of  the  Treasury  of  the  United 
States,  the  Comptroller  of  the  Currency  and  five  other  mem- 
bers appointed  by  the  President  of  the  United  States  by  and 
with  the  consent  of  the  Senate.  Each  of  the  five  receives 
an  annual  salary  of  $12,000  and  his  travelling  expenses, 
the  sum  of  $7,000  per  annum  being  added  to  the  former 
salary  of  the  Comptroller  of  the  Currency.  As  has  been 
stated,  the  powers  of  this  board  are  broad.  It  may  examine 
the  accounts  and  require  reports  from  each  reserve  bank, 
publishing  weekly  a  statement  showing  the  condition  of 
each  reserve  bank  and  a  consolidated  statement  for  all 
reserve  banks;  require  one  reserve  bank  to  rediscount  the 
discounted  paper  of  another;  suspend  the  reserve  require- 
ments of  both  the  reserve  and  member  banks ;  supervise  the 
issue  and  retirement  of  Federal  reserve  notes;  and  change 
the  number  of  reserve  and  central  reserve  cities  or  reclassify 
the  existing  ones.  It  may  create  new  reserve  districts  and 
rearrange  the  old  ones;  appoint  three  of  the  nine  directors 
of  each  reserve  bank ;  suspend  or  remove  any  officer  or  direc- 
tor of  such  bank;  grant  to  any  national  bank,  by  special 
permit,  the  right  to  act  as  trustee,  executor,  administrator 
or  registrar ;  and  finally  perf omi  many  miscellaneous  duties 
that  naturally  fall  under  its  jurisdiction  as  a  supervising 
body. 

The  Federal  Advisory  Council  is  to  be  composed  of  one 
member  from  each  district,  chosen  by  the  board  of  directors 
of  the  reserve  bank  located  therein.  This  council  may  confer 
with  the  board  on  general  business  conditions;  make  oral 
or  written  representations  to  the  board;  and  call  for  in- 
fonnation  and  make  recommendations  upon  several  speci- 
fied matters. 

Note  Issues. — A  plan  is  provided  by  which  the  national 
bank  notes  may  be  gradually  retired  and  replaced  by  the 
notes  of  the  reserve  banks.  To  meet  the  need  for  an  elastic 
currency  the  Act  provides  also  for  Federal  reserve  notes 
to  be  issued  to  the  reserve  banks  at  the  discretion  of  the 
Federal  Reserve  Board.    Application  by  reserve  banks  for 


THE  NEW  LAW  SUMMARIZED  23 

these  notes  must  be  accompanied  by  a  tender  of  the  com- 
mercial paper  and  other  obligations  that  are  acceptable  for 
rediscount  at  the  reserve  banks.  No  reserve  bank  may  pay 
out  the  notes  of  another  except  under  penalty  of  a  tax  of  ten 
per  cent.  The  notes  are  redeemable  at  the  United  States 
Treasury  in  gold  and  at  any  reserve  bank  in  either  gold  or 
lawful  money.  Each  reserve  bank  must  maintain  against 
its  deposits  a  reserve  in  gold  or  lawful  money  of  at  least 
thirty-five  per  cent;  and  against  its  Federal  reserve  notes 
in  actual  circulation,  a  reserve  in  gold  of  forty  per  cent. 
A  graduated  tax  is  provided  for  any  deficiency  in  the 
reserves  held  by  the  reserve  banks  or  by  the  member  banks. 

Reserves. — Reserve  requirements  of  all  subscribing 
member  banks  are  to  be  gradually  altered.  By  the  end  of 
a  period  of  thirty-six  months,  a  bank  in  New  York,  Chicago 
or  St.  Louis  will  be  required  to  keep  a  reserve  of  eighteen 
per  cent  of  its  demand  and  five  per  cent  of  its  time  de- 
posits. Six-eighteenths  of  this  amount  is  to  be  in  its  vaults, 
seven-eighteenths  must  be  with  the  Federal  reserve  bank 
of  its  district,  and  the  balance  either  in  its  vaults  or  in  the 
Federal  reserve  bank,  or  in  both,  at  its  option. 

The  banks  in  forty-seven  other  cities  will  be  required 
to  keep  a  reserve  of  fifteen  per  cent  of  their  demand  de- 
posits and  five  per  cent  of  their  time  deposits.  Five- 
fifteenths  of  this  must  be  in  their  own  vaults,  six-fifteenths 
must  be  with  the  reserve  bank  of  the  district  and  the  balance 
in  their  own  vaults,  or  with  the  reserve  bank,  or  in  both, 
as  they  elect.  Banks  located  elsewhere  must  keep  a  reserve 
of  twelve  per  cent  of  their  demand  deposits  and  five  per  cent 
of  their  time  deposits.  Four-twelfths  of  this  amount  must 
be  kept  in  their  own  vaults,  five-twelfths  with  the  Federal 
reserve  bank  and  the  balance  either  in  their  vaults  or  with 
the  Federal  reserve  bank,  or  both,  as  they  prefer.  These 
regulations  apply  both  to  national  banks  and  to  State  banks 
and  trust  companies  that  may  become  members  of  the  sys- 
tem. A  Federal  reserve  bnnk  may  receive  from  member 
banks,  as  reserves,  eligible  discounted  paper  to  an  amount 
not  exceeding  one-half  of  each  installment  required.  ) 


24        OPERATION  OF  THE  NEW  BANK  ACT 

Other  Provisions. — The  provisions  as  to  bank  examina- 
tions are  changed  in  several  important  particulars.  Exam- 
iners are  to  be  paid  salaries  instead  of  fees,  the  expense  being 
assessed  upon  the  banks  examined,  in  proportion  to  re- 
sources ;  while  loans  and  gratuities  to  examiners  are  strictly 
forbidden.  A  national  bank  not  located  in  New  York, 
Chicago  or  St.  Louis  may  lend  on  improved  and  unencum- 
bered fann  land  within  its  district  not  in  excess  of  fifty  per 
cent  of  the  value  of  the  property  and  for  a  period  not  longer 
than  five  years,  the  aggregate  of  such  loans  by  any  bank 
not  to  exceed  twenty-five  per  cent  of  its  capital  and  surplus 
or  one-third  of  its  time  deposits.  The  Federal  Reserve 
Board  may  from  time  to  time  add  to  the  list  of  cities  in 
which  such  loans  are  forbidden.  National  banks  with  a 
capital  and  surplus  of  $1,000,000  or  more  may,  under  cer- 
tain regulations  and  supervision,  establish  foreign  branches. 
The  Aldrich-Vreeland  Act  of  May  30,  1908,  is  extended 
to  June  30,  1915,  and  a  number  of  its  provisions  are  altered. 

Later  Chapters  Summarized. — The  following  chapters 
are  devoted  to  an  elaboration  of  this  brief  summary.  Each 
important  topic  will  be  treated  separately,  explaining  in 
detail  the  provisions  of  the  bill,  the  changes  thus  introduced 
into  our  banking  law  and  practice,  and  a  comparison  with 
similar  features  in  the  banking  system  of  other  large 
countries. 

From  what  has  been  said  it  will  be  apparent  that  the 
new  law  attempts  to  introduce  certain  needed  reforms  with- 
out tearing  down  any  more  than  is  necessary  of  the  system 
under  which  we  have  been  working.  A  violent  change  in 
banking  law,  that  would  compel  completely  new  methods 
of  conducting  business  and  carrying  on  banking  operations, 
might  easily  have  done  more  harm  than  good.  Business 
habits  and  customs  that  are  the  product  of  years  of  growth 
can  not  easily  be  altered. 

Instead,  there  has  been  an  endeavor  to  build  upon  the 
old.  In  spite  of  many  changes  in  the  regulations  governing 
the  national  banks,  the  great  mass  of  their  operations  will 
remain  substantially  the  same  as  before.    There  has  merely 


THE  NEW  LAW  SUMIVIARIZED  25 

been  imposed  upon  them  a  sort  of  superstructure,  an  organ- 
ization to  which  they  may  in  need  turn  for  help  and  by 
which  they  will  be,  to  a  considerable  extent,  supervised. 
How  successful  this  attempt  may  prove  only  the  future  will 
reveal.  ]\Iany  changes  that  appeared  of  little  consequence 
to  the  framers  of  the  law  may  be  revolutionary  in  their 
effects.  IMany  of  the  proposals  made  with  the  intent  of  help- 
ing the  banking  community  and  the  public  may  fail  utterly. 
It  is  to  be  hoped  that  the  country  may  adapt  itself  to  the 
new  conditions  with  little  or  no  difficulty. 


CHAPTER  III 

The  Regional  System 

A  Central  Bank. — In  the  numerous  discussions  con- 
cerning the  improvement  of  our  banking  and  currency 
laws,  plans  for  a  central  bank  have  been  urged  more  often 
than  almost  any  other  proposal.  In  nearly  every  leading 
country  of  the  world  there  is  found  a  large  bank  acting 
as  the  fiscal  agent  of  its  government  and  as  banker  for  the 
other  banks  of  the  country.  Each  assumes  a  large  measure 
of  responsibility  for  the  banking  situation  and  for  the 
supply  of  gold  within  its  own  country,  holding  the  reserves 
of  the  other  banks  and,  so  far  as  possible,  compelling  them 
to  conduct  their  business  in  a  conservative  manner.  Scot- 
land and  Canada  are  the  only  countries  of  importance  in 
which  this  situation  is  not  found,  while  England,  France, 
Germany,  Russia,  Belgium,  Austria,  Italy  and  Japan  are 
the  conspicuous  illustrations.  In  our  early  history  we  too 
had  experience  with  similar  institutions — the  First  Bank 
of  the  United  States  from  1791  to  1811,  and  the  Second 
Bank  of  the  United  States  from  1816  to  1836.  ^ 

It  has  thus  been  somewhat  natural  that  there  should  be 
frequent  proposals  for  a  single  central  institution  in  the 
United  States.  Those  who  favored  it  have  contended  that 
only  a  central  bank  would  be  able  to  establish  a  more  uni- 
form or  even  a  lower  discount  rate,  to  control  the  movements 
of  gold  into  and  out  of  the  country,  and  to  hold  for  imme- 
diate use  anywhere  the  supply  of  gold,  which  is  the  ultimate 
reserve  of  all  the  banks.  As  proof  of  these  contentions,  our 
own  early  experience  and  the  methods  in  use  abroad  have 
been  cited. 

Objections  to  a  Central  Bank. — On  the  other  hand, 

there  is  in  the  United  States  a  deep-rooted  objection  to  any 

centralization  of  resources  and  power.     The  same  attitude 

of  mind  that  animated  Andrew  Jackson  in  the  30 's,  and 

26 


THE  REGIONAL  SYSTEM  27 

that  at  the  present  time  prefers  State  rather  thau  Federal 
control  of  local  matters,  finds  the  idea  of  a  central  bank 
repugnant.  It  has  also  been  urged  that  the  vast  extent 
and  differences  in  the  economic  development  of  our  terri- 
tory and  the  variety  of  our  resources  make  necessary  a 
system  fundamentally  different  from  that  found  elsewhere; 
that  rates  of  discount  and  policies  may  be  acceptable  in  one 
section  that  are  not  at  all  desirable  in  another;  and  that 
cash  reserves  can  be  guarded  better  by  a  number  of  banks 
than  by  a  single  central  institution.  Thus  under  a  regional 
system  rumors  of  weakness  in  New  York  City  would  not 
create  distrust  in  New  Orleans,  since  the  banks  and  people 
of  the  South  would  not  be  primarily  dependent  on  New 
York,  but  on  a  regional  bank  in  New  Orleans.  Perhaps 
political  considerations  and  questions  of  party  policy  have 
also  had  an  influence. 

Europe  and  the  United  States  Contrasted. — Inasmuch 
as  the  regional  system  is  the  form  chosen  by  Congress,  the 
reasons  for  the  choice  should  be  set  forth  in  their  main 
outlines.  Perhaps  no  clearer  way  of  stating  the  problem 
can  be  found  than  to  contrast  conditions  in  Europe  with 
those  in  the  United  States.  The  mere  statement  of  the 
comparative  area  in  square  miles  is  illuminating.  The 
United  States  has  an  area  of  2,973,890  square  miles,  a  terri- 
tory greater  in  extent  than  all  Europe,  exclusive  of  Russia. 
Even  if  Alaska  be  omitted,  there  are  2,383,006  square  miles 
within  our  domain ;  while  Europe,  excluding  Russia,  has 
but  1,936,320  square  miles.  A  contrast  of  our  great  area 
with  the  121,391  square  miles  in  the  United  Kingdom,  the 
209,000  square  miles  in  Germany  and  the  207,220  S(iuare 
miles  in  France  suggests  at  the  outset  that  a  system  success- 
ful in  any  one  of  those  countries  might  fail  utterly  here. 
If  only  eight  regional  districts  should  be  established  their 
average  area  would  be  297,888  S(iuare  miles,  a  territory 
greater  than  that  of  any  country  in  Europe  except  Russia. 
If  the  United  States  should  be  divided  into  twelve  districts 
their  average  area  would  be  198,583  square  miles,  an  extent 
which  is  exceeded,  and  that  but  slightly,  by  only  Russia, 
Franf^e  and  Germany. 


28        OPERATION  OP  THE  NEW  BANK  ACT 

The  enormous  size  of  our  country  creates  problems  of 
transportation  and  communication  which  are  staggering. 
Of  even  greater  importance  are  the  variety  of  our  resources, 
the  diverse  habits  of  our  people  and  the  dissimilarity  in  busi- 
ness methods  which  are  sure  to  exist  in  so  large  an  area. 
Climate,  temperature,  and  soil  differ  greatly  in  the  various 
groups  of  States.  The  history  and  the  present  stage  of 
development  of  the  several  sections  of  the  country  vary 
widely.  The  character  and  extent  of  our  natural  resources, 
both  developed  and  undeveloped,  furnish  present  and  future 
problems  that  are  peculiar  to  each  region.  We  might,  in 
fact,  say  that  the  United  States  in  itself  furnishes  as  great 
a  variety  of  problems  as  does  all  Europe  combined,  with 
the  single  exception  that  all  our  people  use  the  same  lan- 
guage and  are  one  nation. 

Trouble  Localized  in  Europe. — W^ould  a  single  central 
banking  institution  be  able  at  the  present  time  to  control 
the  reserves  and  solve  the  problems  of  all  Europe?  The 
question  is  certainly  an  open  one  and  a  negative  answer 
would  suggest  that  perhaps  the  same  conclusion  should 
be  drawn  regarding  the  United  States.  The  operation  of 
the  system  in  Europe  has  shown  that  financial  trouble  in 
France  does  not  affect  Great  Britain  and  Germany,  unless 
it  becomes  so  serious  that  national  boundaries  are  insuffi- 
cient as  a  check,  European  experience  gives  rise  to  the  hope 
that  disturbances  in  one  section  of  the  United  States  may 
easily  be  prevented  from  spreading  throughout  the  country, 
if  we  devise  the  proper  banking  machinery. 

The  Regional  Plan. — Wisely  or  unwiseh',  the  final  de- 
cision has  been  against  a  central  bank  and  in  favor  of  a 
number  of  institutions,  known  as  Federal  reserve  banks, 
over  which  there  is  placed  a  controlling  body  named  the 
Federal  Reserve  Board.  For  convenience  we  may,  in  this 
chapter  and  elsewhere,  adopt  the  terms  suggested  in  the 
first  section  of  the  new  law,  which  reads  as  follows :  '  'Wher- 
ever the  word  'bank'  is  used  in  this  Act,  the  word  shall  be 
held  to  include  State  bank,  banking  association,  and  trust 
company,  except  where  national  banks  or  Federal  reserve 


THE  REGIONAL  SYSTEM  29 

banks  are  specifically  referred  to.  The  terms  'national 
bank'  and  'national  banking  association'  used  in  this  Act 
shall  be  held  to  be  synonymous  and  interchangeable.  The 
term  'member  bank '  shall  be  held  to  mean  any  national  bank, 
State  bank,  or  bank  or  trust  company  which  has  become  a 
member  of  one  of  the  reserve  banks  created  by  this  Act. 
The  term  'board'  shall  be  held  to  mean  Federal  Reserve 
Board;  the  term  'district'  shall  be  held  to  mean  Federal 
reserve  district;  the  term  'reserve  bank'  shall  be  held  to 
mean  Federal  reserve  bank." 

The  Work  of  Organization. — The  law  provides  that 
"as  soon  as  practicable"  the  Secretary  of  the  Treasury,  the 
Secretary  of  Agriculture  and  the  Comptroller  of  the  Cur- 
rency, acting  as  "The  Reserve  Bank  Organization  Commit- 
tee," shall  designate  not  less  than  eight  nor  more  than 
twelve  cities  to  be  known  as  Federal  reserve  cities,  and  shall 
divide  the  continental  territory  of  the  United  States,  exclud- 
ing Alaska,  into  districts,  each  district  to  contain  one  such 
city.  In  each  of  these  cities  there  will  be  established  a 
Federal  reserve  bank,  which  later  ma.y  have  branches  in 
various  parts  of  its  district.  The  decision  of  this  committee 
is  subject  to  review  only  by  the  Federal  Reserve  Board. 
In  the  choice  of  the  cities  and  in  the  apportionment  of  the 
districts  empha.sis  must  be  placed  on  "the  convenience  and 
customary  course  of  business"  rather  than  on  State  boun- 
daries. The  Reserve  Board  may  readjust  these  districts  and 
from  time  to  time  create  new  ones,  not  to  exceed  twelve  in  all. 

Districting  the  United  States. — This  task  of  districting 
the  country  will  he  (lirficult  Ix'fause  of  the  complex  nature 
of  the  prnl)lem,  the  lack  of  detailed  information  on  the  sub- 
ject and  the  strong  rivalry  among  the  cities  anxious  to  have 
one  of  the  reserve  banks.  The  committee  must  take  into 
account  the  distance  from  one  city  to  another,  the  relative 
importance  of  the  business  done  in  the  different  centers, 
the  present  movements  of  commerce  between  these  localities 
and  the  convenience  or  inconvenience  to  trade  if  the  present 
movements  are  altered.  Attention  must  also  be  given  to  the 
fact  that  the  new  system  will  impose  powers  and  duties  upon 


30        OPERATION  OF  THE  NEW  BANK  ACT 

the  new  institutions  that  may  change  the  existing  situation. 
It  may  be  that  some  of  the  present  channels  of  business  are 
by  no  means  incapable  of  change  and  would  be  improved  by 
alteration. 

Before  coming  to  any  conclusion  there  should  be  a  thor- 
ough analysis  of  the  movements  of  commodities,  of  the 
methods  now  used  in  paying  for  them,  and  of  the  movements 
of  cash  from  one  part  of  the  country  to  another.  The  extent 
of  the  borrowing  from  one  section  by  another,  the  method 
by  which  these  funds  are  loaned  and  the  security  given 
should  also  be  understood,  since  it  will  be  desirable  to  have 
each  district  as  independent  of  the  others  as  possible.  Since 
the  eastern  sections  of  our  country  were  settled  and  devel- 
oped before  the  West  and  the  South,  the  cities  of  that  region 
are  larger  in  population  and  in  banking  resources,  a  fact 
that  will,  to  a  considerable  extent,  offset  the  shorter  dis- 
tances between  them. 

The  Organization  Committee. — At  the  time  of  the 
passage  of  the  new  law  the  office  of  the  Comptroller  of  the 
Currency  was  vacant,  no  successor  to  Mr.  Lawrence  0. 
Murray,  the  former  incumbent,  having  been  appointed. 
Since  "a  majority  of  the  organization  committee  shall  con- 
stitute a  quorum  with  authority  to  act ' '  the  other  two  mem- 
bers,— Secretary  McAdoo  of  the  Treasury  Department  and 
Secretary  Houston  of  the  Department  of  Agriculture, — at 
once  began  consideration  of  the  problem  and  made  public 
their  plan  of  action.  Beginning  in  New  York  City  on  Janu- 
ary 4,  1914,  they  held  hearings  that  are  expected  to  continue 
in  one  after  another  of  a  number  of  leading  cities.  Repre- 
sentatives of  the  sections  of  the  country  contiguous  to  each 
city  have  been  given  an  opportunity  to  appear  and  to  ex- 
press their  views.  The  attitude  of  the  committee  toward 
the  problem  and  the  factors  they  consider  most  important 
are  indicated  by  the  following  quotations  from  an  announce- 
ment by  them  on  December  26,  1913 : 

"  The  committee  desires  to  be  informed  particularly  upon  the 
following  points,  which  are  considered  primary  factors  in  determin- 
ing the  boundaries  of  the  proposed  districts  and  the  location  of  the 
Federal  reserve  banks: 


THE  REGIONAL  SYSTEM  31 

■■  First.  Geographical  convenience,  wliicli  involves  transporta- 
tion facilities  and  rapid  and  easy  coniniunicatiou  with  ail  parts  of 
the  district. 

"  Second.  Industrial  and  commercial  development  and  needs 
of  each  section,  which  involves  consideration  of  the  general  move- 
ment of  commodities  and  of  business  transactions  witiiin  tiie  dis- 
tricts and  tlie  transfer  of  funds  and  exchanges  of  credits  arising 
therefrom. 

"  Tliird.  The  establislied  custom  and  trend  of  business,  as  de- 
veloped by  the  present  system  of  bank  reserves  and  checking  accounts. 
In  laying  out  tlie  districts  and  establishing  the  headquarters  for 
reserve  banks,  every  eil'ort  will  be  made  to  promote  business  con- 
venience and  normal  movements  of  trade  and  commerce. 

'■  Political  considerations  will  not  be  permitted  to  inlluence  the 
committee  in  determining  tliese  important  questions.  Wbile  tlie 
committee  appreciates  the  local  pride  and  sentiment  wliich  are 
prompting  many  cities  to  urge  tlieir  claims,  the  committee,  never- 
theless, must  appeal  to  tlie  patriotism  of  the  country  to  assist  it  in 
arriving  at  sound  conclusions  tlirough  consideration  of  fundamental 
and  vital  factors.  I'urely  local  sentiment  and  pride  must  yield  to  tlie 
common  good  in  order  that  the  system  itself  may  accomplish  tiie 
purposes  for  wliich  it  was  designed,  namely,  to  secure  to  the  business 
of  the  country  tlie  elastic  system  of  credits  and  the  stability  of  con- 
ditions so  long  imperatively  demanded. 

"  The  committee  will  not,  therefore,  be  able  to  receive  delegations 
urging  the  claims  of  particular  cities  for  preference  as  the  head- 
quarters of  tiie  reserve  banks.  The  claims  of  all  cities  will  be  con- 
sidered upon  their  merits  in  view  of  all  the  facts  which  will  be  de- 
veloped tluougii  tlie  investigations.  The  purjiose  of  the  committee  is 
to  go  about  tills  work  in  a  thoroughly  practical  and  businesslike  way, 
to  aceomiilish  it  at  the  earliest  possible  moment  but  without  undue 
liaste,  and  only  after  full  consideration  of  the  needs  of  every  section 
of  the  country." 

The  Proper  Number  of  Districts. — The  Federal  Keserve 
Act  specifies  that  there  shall  not  be  less  than  eight  districts 
nor  more  than  twelve  districts,*  and  the  organization  com- 
mittee may  decide  upon  any  number  within  these  limits.  A 
rumor  has  been  circulated  to  the  effect  that  they  plan  to 
choose  the  maximum  number  at  the  outset.  This  report 
may  be  false,  but  such  a  decision  appears  upon  its  face  to  be 
a  wise  one.  If  less  tlian  twelve  districts  are  organized  at 
once,  there  will  be  contiinied  and  persistent  agitation  from 
the  disappointed  cities  for  the  addition  of  new  districts, 
until  the  maximum  number  have  finally  been  designated. 
So  many  are  seeking  the  honor  of  a  reserve  bank  tliat  some 

*  The  actual  districting  is  shovm  on  page  38. 


32        OPERATION  OF  THE  NEW  BANK  ACT 

must  of  necessity  be  omitted.  The  settlement  of  the  whole 
matter  at  the  outset  will  probably  mean  less  trouble  in  the 
end. 

It  must  also  be  remembered  that  the  addition  of  other 
districts  will  be  difficult  to  effect.  If  eight  are  designated 
at  the  outset,  the  addition  of  two  or  four  more  at  the  end 
of  a  year,  for  example,  means  the  undoing  of  much  that  has 
already  been  accomplished.  A  district  already  organized  and 
in  working  order  must  be  divided  into  two  smaller  ones,  or 
several  of  the  older  districts  must  each  yield  a  part  of  its 
territory  to  form  a  new  one.  It  might  even  be  that  an  old 
district  w^ould  be  abolished  and  part  of  its  territory  given 
to  one  new  district  and  part  to  another.  The  proper  loca- 
tion of  the  reserve  banks  for  eight  or  ten  districts  might 
be  different  than  for  twelve  districts.  If  eight  are  estab- 
lished and  the  others  added  later,  geographical  considera- 
tions alone  might  require  the  removal  of  a  reserve  bank 
from  the  city  in  which  it  was  first  located.  A  complete  rear- 
rangement of  boundaries  might  become  a  necessity,  local 
interests  and  jealousies  would  then  be  aroused  and  many  of 
the  problems  involved  in  the  original  selection  would  again 
arise  for  solution. 

The  Effect  on  Business. — But  these  considerations  are 
not  the  most  important.  The  introduction  of  the  new 
system  means  a  very  marked  change  in  banking  methods 
and  in  business.  More  careful  scrutiny  of  paper,  a  new 
location  of  reserves,  the  privilege  of  rediscounting,  more 
rigid  examinations  and  several  modifications  in  accounting 
methods  are  among  the  most  important  changes  for  the 
banks;  while  the  business  public  may  to  advantage  also 
modify  its  practices  to  a  considerable  extent.  No  matter 
how  reasonable  these  changes  appear,  nor  how  much  better 
experience  may  prove  them  to  be,  account  must  be  taken 
of  the  influence  of  conservatism  and  prejudice.  Trade 
movements  may  not  be  modified  to  suit  the  new  machinery, 
but  methods  of  pajTnent  and  collection  will  surely  be 
affected.  Changes  breed  hesitancy  and  distrust,  and  as 
few  as  possible  should  occur.    Hence  it  is  the  part  of  wis- 


THE  REGIONAL  SYSTEM  33 

doin  to  settle  the  problem  as  fully  as  possible  at  the  outset 
by  a  choice  of  the  full  number  of  districts. 

The  Demand  for  Reserve  Banks. — Perhaps  a  few  words 
should  be  said  couceriiing  the  present  rivalry  between  the 
cities  that  are  eager  for  reserve  banks.  It  seems  to  be 
generally  conceded  that  New  York  and  Chicago  will  be  on 
the  list  because  of  their  location  and  their  financial  prom- 
inence. San  Francisco  and  New  Orleans  come  next,  but 
upon  the  rest  of  the  number  there  is  no  consensus  of  opin- 
ion. Boston,  Philadelphia,  Baltimore  and  Washington  are 
asking  for  recognition  in  the  East ;  Atlanta  and  Houston, 
(Texas)  are  mentioned  for  the  South;  St.  Louis,  Kansas 
City,  JNIemphis,  Cincinnati,  Cleveland  and  Minneapolis  in 
the  Middle  West;  with  Denver,  Los  Angeles  and  Portland 
(Oregon)  in  the  West.  Still  other  cities  have  been  suggested, 
but  most  of  the  discussion  centers  about  the  ones  named. 
Only  the  most  careful  sifting  and  weighing  of  the  mass  of 
evidence  that  will  be  presented  will  make  a  proper  choice 
possible.  The  committee  is  authorized  to  employ  counsel 
and  expert  aid,  to  take  testimony,  and  in  other  ways  to  con- 
duct such  investigations  as  may  be  deemed  necessary. 

The  Size  and  Strength  of  the  Districts. — To  what  ex- 
tent the  size  of  the  banking  institutions  in  a  given  city  may 
affect  its  selection  as  the  location  of  a  reserve  city  is  diffi- 
cult to  determine.  No  reserve  bank  may  commence  business 
with  a  subscribed  capital  of  less  than  $4,000,000.  If  all 
of  this  sum  is  to  be  subscribed  by  banks,  each  district  must 
contain  member  banks  with  a  combined  capital  and  surplus 
of  at  least  $66,666,666.  A  suggestion  of  the  significance  of 
this  is  found  in  the  fact  that  the  combined  capital  and 
surplus  of  all  the  national  banks  of  the  United  States  on 
October  21,  1913,  was  $1,785,705,285.  Just  how  many  banks 
will  join  the  system  is  uncertain,  although  the  indications 
at  present  are  that  a  very  large  number  will  enter.  Perhaps 
it  is  safe  to  assume  that  enough  State  banks  will  join  to 
offset  whatever  refusals  there  are  on  the  part  of  the  national 
banks.  In  that  event,  we  may  accept  tentatively  the  statis- 
tics of  the  national  banks  as  indicative  of  the  strength  of 
the  system. 
3 


34         OPERATION  OF  THE  NEW  BANK  ACT 

The  amount  of  the  maximum  possible  subscription  from 
national  banks  is  six  per  cent  of  the  combined  capital  and 
sui'plus,  or  $107,142,317.  Divided  among  twelve  districts, 
the  average  for  each  is  $8,928,526.  Six  per  cent  of  the  com- 
bined capital  and  surplus  of  the  national  banks  of  New  York 
City  is  $14,958,300,  of  Chicago  $4,143,000,  of  Philadelphia 
$3,723,900,  and  of  Boston  $2,906,700.  It  is  evident  that  if 
a  reserve  bank  is  located  in  any  one  of  these  cities  the  dis- 
trict surrounding  each  must  be  closely  limited  unless  the 
areas  of  the  other  districts  are  made  so  large  as  to  be  un- 
wieldy merely  from  their  size.  If  they  are  made  small,  it 
may  be  necessary  to  supplement  the  bank  subscriptions  by 
offering  stock  to  the  public  in  order  to  secure  the  $4,000,000 
required  for  each.  A  district  which  would  include  the  New 
England  and  Eastern  States  would  contain  national  banks 
with  a  combined  capital  and  surplus  of  $852,521,773.38, 
six  per  cent  of  which  would  be  $51,151,306.39,  or  nearly 
one-half  of  the  subscriptions  to  be  secured  from  all  the 
national  banks  in  the  United  States. 

Entering  the  System. — The  number  of  districts  and 
the  location  of  the  reserve  banks  having  been  determined, 
the  committee  will  proceed  with  the  M'ork  of  organization. 
Every  national  bank  is  required,  and  every  other  eligible 
bank,  as  well  as  every  trust  company  in  the  District  of 
Columbia,  is  authorized  to  signify  in  writing,  within  sixty 
days  after  the  passage  of  the  Act,  its  acceptance  of  the  terms 
and  provisions  thereof.  The  Act  was  signed  by  President 
Wilson  on  December  23,  1913,  and  the  committee  has  an- 
nounced that  the  national  banks  must  signify  their  accept- 
ance not  later  than  February  22,  1914.  If  a  national  bank 
within  a  reserve  or  central  reserve  city  does  not  signify 
acceptance  before  that  date  the  organization  committee  or 
the  Reserve  Board  may,  at  its  discretion,  give  thirty  days' 
notice  to  such  bank,  at  the  end  of  which  time  it  shall  cease 
to  act  as  a  reserve  agent  for  other  banks  under  the  pro- 
visions of  the  National  Bank  Act.  If  this  thirty  days' 
notice  is  promptly  given  on  February  22,  the  banks  in  ques- 
tion could  be  compelled  to  surrender  these  privileges  by 


THE  REGIONAL  SYSTEM  35 

March  24,  1914.  Although  the  organization  committee  and 
the  Reserve  Board  are  allowed  discretion  in  the  matter  and 
may  not  see  fit  to  act  at  once,  they  have  the  power  to  compel 
a  prompt  decision  by  any  national  bank  in  a  reserve  or 
central  reserve  city.  The  announcement  made  on  December 
26,  1013,  suggests  their  intention  to  take  prompt  actioji, 
since  it  states  that  "all  national  banks  are  required  to  sig- 
nify their  acceptance"  on  or  before  February  22,  1914. 
If  any  national  bank  in  a  reserve  or  central  reserve  city 
fails  to  act  before  that  date  it  may  at  once  receive  the  neces- 
sary thirty  days'  notice  that  it  is  to  lose  its  reserve  privileges. 

National  Banks  Must  Enter, — The  law,  however,  spe- 
cifically compels  all  the  national  banks  to  become  members 
within  one  year,  i.e.,  by  December  23,  1914.  No  matter 
what  leniency  may  be  shown  by  the  committee  or  by  the 
Reserve  Board,  national  banks  which  have  not  become  mem- 
ber banks  by  that  time  will  forfeit  their  charters.  Thus 
within  one  year  all  national  l)anks  must  enter  the  system, 
become  State  institutions  or  withdraw  from  the  banking 
business.  State  banks  are  allowed  to  enter  if  they  wish, 
but  are  not  required  to  do  so. 

The  Question  of  Compulsion. — This  provision  that  all 
national  banks  failing  to  enter  the  system  within  one  year 
shall  forfeit  their  charters  has  raised  several  questions.  The 
committee  has  announced  that  a  vote  by  the  directors  in 
favor  of  entering  the  system  shall  be  considered  sufficient 
approval  without  a  reference  of  the  matter  to  the  stock- 
holders. But  if  the  directors  vote  adversely,  they  must 
refer  it  to  the  stockholders  for  final  decision,  since  the 
adverse  vote  would  mean  the  loss  of  the  bank's  charter. 

Since  the  constitntionnlity  of  compelling  the  banks  to 
enter  has  liocii  riuestioiicd,  there  has  been  inserted  in  tlie 
Act  the  following  provision  : 

"Any  noncompliance  with  or  violation  of  this  Act  shall, 
however,  be  determined  and  adjudged  by  any  court  of  the 
United  States  of  competent  jurisdiction  in  a  suit  brought 
for  that  purpose  in  the  district  oi*  tcri-itory  in  which  such 


36        OPERATION  OF  THE  NEW  BANK  ACT 

bank  is  located,  under  direction  of  the  Federal  Reserve 
Board,  by  the  Comptroller  of  the  Currency  in  his  own 
name  before  the  association  shall  be  declared  dissolved." 
To  cover  other  violations  than  merely  that  of  failing  to 
become  a  member,  the  following  is  added  to  the  paragraph 
from  which  the  above  quotation  is  taken.  Its  significance 
for  directors  of  national  banks  is  so  obvious  as  to  need  no 
comment. 

"In  cases  of  such  noncompliance  or  violation,  other  than 
the  failure  to  become  a  member  bank  under  the  provisions 
of  this  Act,  every  director  who  participated  in  or  assented 
to  the  same  shall  be  held  liable  in  his  personal  or  individual 
capacity  for  all  damages  which  said  bank,  its  shareholders, 
or  any  other  person  shall  have  sustained  in  consequence  of 
such  violation." 

The  Banks  Ready  to  Enter. — There  seems  little  reason 
to  doubt  that  most  of  the  national  banks  will  enter  promptly. 
Even  before  the  report  of  the  conference  committee  had 
been  passed  bj^  the  Senate  and  the  House  of  Representatives, 
the  Secretary  of  the  Treasury  received  large  numbers  of 
letters  and  telegrams  indicating  a  desire  to  join.  But  even 
if  some  of  the  banks  should  hesitate,  the  reserve  banks  need 
not  be  crippled  by  a  lack  of  capital.  Each  must  have  a 
subscribed  capital  stock  of  at  least  $4,000,000,  of  which  each 
member  bank  must  subscribe  an  amount  equal  to  six  per  cent 
of  its  capital  and  surplus.  One-half  of  this  must  be  paid 
from  time  to  time  within  six  months  of  the  call  of  the 
organization  committee  or  of  the  Reserve  Board.  The  other 
one-half  is  subject  to  call.  An  early  demand  for  this  latter 
amount  would  involve  such  hardship  for  member  banks 
that  it  might  be  unwise  to  demand  it,  and  fortunately  an- 
other resoiu'ce  is  open.  If  subscriptions  by  the  banks  are, 
in  the  judgment  of  the  organization  committee,  insufficient, 
the  general  public  may  be  asked  to  furnish  such  additional 
amounts  as  are  needed.  If  there  still  is  not  enough,  the 
United  States  itself  will  purchase  the  necessarA^  balance, 
paying  for  it  with  money  in  the  Treasury  not  otherwise 


THE  REGIONAL  SYSTEM  37 

appropriated.  Tliis  altornative  of  an  appeal  to  the  public 
and  to  the  government  for  capital  lessens  the  emphasis 
that  must  be  given  to  the  capital  and  surplus  of  the  banks 
in  a  proposed  district.  It  might  be  possible,  for  example, 
to  locate  a  reserve  bank  in  Seattle,  even  though  the  banking 
capital  and  surplus  in  the  contiguous  territory  were  insuffi- 
cient for  the  purpose. 

Prompt  Action  Possible. — There  is  thus  every  reason 
to  believe  that  the  organization  committee  may  proceed 
promptly  with  its  work.  The  next  step  is  to  file  with  the 
Comptroller  of  the  Currency  a  certificate  showing  the  limits 
of  the  districts  and  the  Federal  reserve  city  designated  in 
each.  The  Comptroller  will  forward  to  each  national  bank, 
and  to  such  other  banks  as  are  declared  eligible  by  the 
organization  committee,  an  application  blank  containing  a 
resolution  in  proper  form  for  adoption  by  the  directors  of 
the  bank  wishing  to  join.  The  organization  committee  will 
then  designate  any  five  of  the  banks  that  apply  to  execute 
a  certificate  of  organization  which  shall  state  the  name  of 
the  Federal  reserve  bank,  the  territorial  extent  of  its  dis- 
trict, the  city  and  Slate  in  which  it  is  to  be  located  and 
other  necessary  information.  This  certificate,  after  aclcnowl- 
edgment  before  a  judge  of  some  court  of  record  or  a  notary 
public,  is  to  be  transmitted  to  the  Comptroller  of  the  Cur- 
rency, who  will  file  and  record  it. 

By  this  process  the  Federal  reserve  bank  becomes  a  body 
corporate  with  certain  specified  powers  which  will  later  be 
described.  No  business  may  be  transacted,  except  such  as  is 
incidental  and  preliminary  to  organization,  until  authoriza- 
tion to  do  so  is  granted  by  the  Comptroller  of  the  Currency. 
The  reserve  bank's  affairs  are  to  be  directed  and  controlled 
by  a  Board  of  Directoi-s  whose  chairman  is  appointed  by  the 
Federal  Reserve  Board  and  who  will  be  known  as  a  "Fed- 
eral reserve  agent."  This  chairman  will  direct  the  election 
of  the  directors  in  a  manner  described  in  a  later  chapter. 
In  case  he  has  not  yet  been  appointed  this  work  will  be 
directed  bv  the  organization  committee. 


38 


OPERATION  OF  THE  NEW  BANK  ACT 


The  Reserve  Bank  Organization  Committee  announced  its  decision  determining 
the  Federal  reserve  districts  and  the  location  of  the  Federal  reserve  banks  on  April 
10,  1914.  Twelve  districts  were  established,  the  boundaries  of  which  are  indicated 
upon  the  above  map,  which,  in  addition,  shows  the  location  of  the  twelve  Federal 
reserve  banks  and  the  number  assigned  to  each.  Protests  have  been  lodged  with 
the  Federal  Reserve  Board  by  Baltimore,  seeking  to  displace  Richmond  as  the  seat 
of  bank  No.  5;  by  New  Orleans,  which  desires  to  be  the  seat  of  bank  No  6;  by 
Pittsburgh,  which  is  endeavoring  to  displace  Cleveland,  and  also  by  the  member 
banks  of  a  number  of  districts  which  would  like  to  have  the  boundaries  changed. 
These  appeals  are  now  pending.  The  relative  size  of  the  twelve  banks  is  shown  by 
the  following  weekly  statement: 


THE  TWELVE  FEDERAL 


!.T 

S 

5fe& 

2i,-.'i 

■i^. 

S^; 

Louis     a^uT 

Kaiuai 

..,„ 

eiuo 

Total 

Legal  .  lender    ooles,    silver 

116.086 

sgs,8si 
B.334 

4.8II7'         032 

B.800 

t3,701 
2,313 

.30,002 

110,154  S10,33Q 

.11,400 

.7,403 

.10,507 

.250.250 

T 

»18,427 

S108.21S 

S21.4a7lsi0,7C6 

tt.844 

S0.074 

"Z 

•  12.063 

"- 

.10,003 

'«"•*—'■■"'■""■■ 

::: 

1,^77 

17,000 

"" '""  S&.m''"''  "" 

b     risoutou 

OOSJ        100 

10 

.05 

50 

81 

1,00. 

401 

ToUl„™,.„..    -. 

•1M.S 

•129,200 

B.,I0<,BI.50<i 

S13,30O 

110,404 

HS,ioa 

.10,71. 

.11,701 

•12,900 

.11,410 

.19.330 

•320,022 

Itctwrve   deposilB   made   by 

S1S,0G0 

1122,560 

..««U.,n 

1,004 

.«0. 

.13,072 

«.s. 

.0,878 

'■■:: 

.,3,04. 

D„.  .0  ..h.,    F.J.,.I  .^ 

''%'Sjr''(".t°™™Si)''' 

4  185 

Cspitd  paid  in 

3,23, 

6.640 

4,  HI       4.026 

4,3.2 

1,843 

1.619 

3S.841 

TO--""'"" 

..8,«6 

..2M0o|,«,10OjUWO» 

.13,300 

S10.401 

«0,100 

.15,715;811,78, 

,,2,900 

.11,416 

.10,330 

.325,022 

o 


CHAPTER  IV 

Ownership 

The  regional  system  having  been  chosen,  the  next  im- 
portant problem  to  be  settled  by  Congress  was  that  of 
ownership.  The  decision  was  in  favor  of  compulsory  sub- 
scription by  the  banks  to  be  supplemented;  if  necessary, 
by  an  appeal  to  the  public  and  finally  to  the  government 
itself. 

Value  of  Public  Subscriptions. — There  is  much  to  be 
said  in  favor  of  subscription  by  the  general  public.  To  a 
constantly  increasing  extent,  national,  State  and  local  gov- 
ernments are  offering  their  securities  direct  to  the  people. 
Such  a  procedure  increases  popular  interest  in  all  govern- 
mental matters,  affords  a  safe  investment  for  funds,  and 
makes  available  for  public  uses  a  large  amount  of  capital 
that  otherwise  might  be  hoarded.  Also,  it  may  be  urged  that 
our  new  system  is  an  enterprise  of  such  general  interest  and 
importance  that  it  should  be  owned  by  the  people;  that 
through  public  subscription  more  capital  could  be  secured 
and  the  reserve  banks  thus  be  made  stronger:  and  that 
ownership  by  the  banks  of  an  institution  that  is  to  compete 
with  them  in  some  lines  of  business  and  regulate  them  in 
others,  is  incongruous  and  dangerous. 

Our  own  history  and  the  practice  of  other  countries  are 
interesting.  The  stock  of  the  Fi?-st  Bank  of  the  United 
States  was  $10,000,000,  of  which  four-fifths  was  owned  by 
the  general  pu])lic  and  one-fifth  by  the  government.  The 
$35,000,000  capital  of  the  Second  Bank  of  the  TTnited  States 
was  subscriliod  for  by  the  public  and  the  government  in  the 
same  proportions  as  in  the  case  of  the  earlier  bank.  The 
bank  of  England  has  over  10,000  stockholders,  no  stock  be- 
ing held  by  the  government.  There  are  no  restrictions 
upon  ownership  and  ti'nnsf(>r  of  this  stock  so  that  banks 
may.  if  they  wish,  become  stockholders.     Tlie  Reichsbank 

39 


40    OPERATION  OF  THE  NEW  BANK  ACT 

of  Germany  has  18,000  stockholders,  the  Bank  of  France 
32,000,  the  Bank  of  Italy  nearly  10,000  and  the  Bank  of 
Switzerland  10,000.  In  none  of  these  countries  are  there 
requirements  or  restrictions  upon  ownership,  except  that  in 
Germany  officials  of  the  Reichsbank  may  not  own  shares, 
and  in  France  about  6,000  shares  of  the  Bank  of  France, 
belonging  to  widows,  minors,  etc.,  are  marked  "not  trans- 
ferable." Precedent,  and  practice  seem  to  be  either  in  favor 
of  wide  ownership  with  no  restrictions  or  a  partial  or  even 
complete  ownership  by  the  government.  As  an  illustration 
of  the  latter  solution  the  Bank  of  Sweden,  which  belongs  to 
Parliament,  there  being  no  stockholders,  may  be  cited. 

Ownership  vs.  Control. — Before  presenting  the  argu- 
ments for  bank  ownership  it  may  be  well  to  observe  that 
there  is  a  very  pronounced  difference  between  ownership 
and  control — a  fact  that  is  often  forcibly  impressed  upon 
stockholders  of  companies  whose  directors  have  not  always 
considered  the  best  interest  of  the  real  owners.  If  control 
of  the  reserve  banks  be  placed  elsewhere  than  with  the  banks 
of  the  country,  the  alleged  danger  of  bank  ownership  might 
be  lessened.  This  has  been  attempted  by  the  creation  of 
the  Federal  Eeserve  Board  with  very  sweeping  powers,  and 
by  leaving  a  large  number  of  very  important  questions  to 
be  decided  by  the  Secretary  of  the  Treasury,  It  is  also  to 
be  observed  that  the  reserve  banks  are  not  to  have  as  close 
business  relations  with  the  public  as  do  the  leading  central 
banks  of  Europe.  These  two  considerations  weaken,  even 
though  they  do  not  fully  answer,  the  contentions  against 
bank  ownership. 

Arguments  for  Ownership  by  the  Banks. — There  are 
several  arguments  directly  in  favor  of  requiring  the  banks 
to  purchase  the  stock.  The  reserve  banks  are  to  hold  a  con- 
siderable part  of  the  reserves  of  the  member  banks  through- 
out the  country ;  the  Secretars^  of  the  Treasury  has  the 
discretionary  power  to  deposit  with  them  all  or  any  part 
of  the  general  fund  of  the  Treasury,  not  including  the 
redemption  fund ;  and  they  may  be  required  to  act  as  fiscal 
agents  of  the  government.     Although  subject  to  very  ex- 


OWNERSHIP  41 

plicit  general  control  by  the  Reserve  Board,  the  majority 
of  the  board  of  directors  of  each  reserve  bank  are  to  be 
chosen  by  the  member  banks,  and  a  considerable  part  of  the 
success  of  such  an  institution  will  be  dependent  upon  the 
hearty  cooperation  of  the  banks.  As  stockholders  and  de- 
positors their  incentive  to  helpfulness  will  be  greatly  in- 
creased. They  will  have  little  to  gain  and  much  to  lose  by 
hostility  to  such  a  bank.  Their  reserves  are  with  it  and 
they  have  an  opportunity  for  a  six  per  cent  return  on  their 
holdings  of  stock. 

The  Banks  Held  Responsible. — Their  stock  ownership 
makes  it  possible  for  Congress  to  justify  itself  "in  putting 
on  the  member  banks  the  prime  responsibility  of  adminis- 
tering these  banks  and  safeguarding  their  own  reserves 
and  their  own  capital  stock,  and  making  them  responsible  to 
the  country  for  safeguarding  the  welfare  of  the  national 
banking  system  and  protecting  the  national  gold  supply 
under  the  safeguard  of  governmental  supervision."  This 
sense  of  responsibility  will  render  safer  the  large  deposits 
of  government  money,  and  will  also  protect  the  United 
States  in  its  extension  of  credit  through  the  new  note  issues 
which  are  "the  obligations  of  the  United  States  loaned  to 
the  reserve  banks  against  commercial  bills." 

These  considerations  do  not,  however,  touch  the  consti- 
tutionality or  the  justice  of  requiring  the  national  banks 
to  subscribe.  The  justice  of  the  requirement  is  dependent 
largely  on  the  advantages  to  them  of  membership  in  the 
system.  In  the  National  Bank  Act,  Congress  has  specifically 
reserved  the  right  to  amend,  alter  or  repeal  the  Act  itself, 
a  reservation  which  may  fully  cover  the  right  of  Congress 
to  require  subscriptions.  The  writers  of  this  volume  do  not 
consider  themselves  competent  to  pass  upon  this  point,  and 
express  no  opinion.  Any  bank  wishing  to  test  this  com- 
pulsory feature  has  open  to  it  the  courts  of  competent  juris- 
diction. 

The  banks  then  are  to  be  offered  the  first  opportunity 
to  subscribe  for  stock,  with  the  public  next  and  the  govern- 
ment last.   Stockholders  are  subject  to  double  liability,  and 


42        OrERATION  OF  THE  NEW  BANK  ACT 

none  except  member  banks  are  allowed  to  subscribe  for  or 
to  hold  at  any  one  time  more  than  $25,000  par  value  of  the 
new  stock.  Stock  offered  to  the  public  shall  be  known  as 
''public  stock."  That  taken  by  the  government  is 
referred  to  in  the  Act  as  "United  States  Stock." 
It  is  "to  be  held  by  the  Secretary  of  the  Treasury 
and  disposed  of  for  the  benefit  of  the  United  States  in 
such  manner,  at  such  times,  and  at  such  price,  not  less 
than  par,  as  the  Secretary  of  the  Treasury  shall  de- 
termine. Stock  not  held  by  member  banks  shall  not  be 
entitled  to  voting  power."  As  member  banks  increase  and 
decrease  their  capital  and  surplus,  their  holdings  of  stock 
in  the  reserve  banks  and  their  liabilities  for  unpaid  subscrip- 
tions still  subject  to  call  are  altered  proportionately.  These 
provisions  imply,  though  they  do  not  explicitly  state,  that 
a  member  bank  may  not  later  purchase  in  the  market  public 
stock  or  United  States  stock  either  to  increase  its  influence 
over  the  reserve  bank  or  as  an  investment.  The  par  value  of 
each  share  is  placed  at  one  hundred  dollars. 

Eligibility  to  Membership. — Not  all  banks  of  the  coun- 
try are  eligible  to  membership.  All  national  banks  are  re- 
quired to  enter  and  every  trust  company  in  the  District  of 
Columbia  may  make  application  for  membership.  No 
special  standards  of  membership  are  set  for  these  insti- 
tutions, as  the  National  Bank  Act  and  the  laws  governing 
trust  companies  in  the  District  of  Columbia  are  sutScienth' 
strict.  Aside  from  these  two  groups,  any  bank  incorporated 
by  special  law  of  any  State  or  organized  under  the  general 
laws  of  any  State  or  of  the  United  States  may  make  appli- 
cation. This  seems  to  include  all  State  banks  and  trust 
companies  and  even  private  banks  in  those  States  where 
there  are  general  laws  governing  their  organization.  Pro- 
vision is  made  in  Section  8  for  the  conversion  of  State  banks 
into  national  banks,  the  statute  which  has  regulated  this 
in  the  past  being  slightly  amended. 

Eligibility  to  apply  does  not  mean  prompt  admission  to 
membership.  Everv^  applying  bank  must,  before  admission, 
(1)  possess  "  a  paid-up,  unimpaired  capital  sufficient  to 
entitle  it  to  become  a  national  banking  association  in  the 


OWNERSHIP  43 

place  where  it  is  situated;"  (2)  comply  with  the  rpserve 
requirements  prescribed  by  the  organization  committee  or 
by  the  Federal  Reserve  Board;  (3)  conform  to  the  laws 
"imposed  on  national  banks  respecting  the  limitation  of  lia- 
bility which  may  be  incurred  by  any  person,  firm  or  cor- 
poration to  such  banks,  the  prohibition  against  making 
purchases  of  or  loans  on  stock  of  such  banks,  and  the  with- 
drawal or  impairment  of  capital,  or  the  payment  of  un- 
earned dividends,  and  to  such  rules  and  regulations  as  the 
Federal  Reserve  Board  ma.y,  in  pursuance  thereof,  pre- 
scribe;" and  (4)  "submit  to  the  examination  and  regula- 
tions prescribed  by  the  organization  committee  or  by  the 
Federal  Reserve  Board." 

Amount  of  Capital. — The  significance  of  these  require- 
ments is  not  perhaps  self-evident.  The  National  Bank  Act 
specifies  that  a  national  bank  organized  in  a  place  with 
a  population  of  3,000  or  less,  must  have  a  capital  of  at  least 
$25,000;  from  three  thousand  to  six  thousand  population, 
a  capital  of  $50,000;  from  six  thousand  to  fifty  thousand 
population,  a  capital  of  $100,000;  and  with  a  population  of 
fifty  thousand  or  over,  a  capital  of  $200,000.  Banks  may 
be  organized  in  many  States  with  much  less  than  $25,000 
capital,  and  these  banks  must  increase  their  capitalization 
if  they  are  to  enter  the  system. 

There  will  be,  however,  one  or  two  peculiarities  in  the 
application  of  the  new  law  and  in  its  effects.  In  earlier 
years  the  capital  requirements  of  the  national  banks  were 
lower  than  at  present.  As  a  result  there  are  a  few  national 
banks  now  in  existence  whose  capital  is  less  than  is  now 
required  of  a  new  bank  located  in  the  same  city,  because 
they  were  organized  years  ago  under  the  earlier  provisions 
of  the  National  Bank  Act.  This  will  probably  cause  no 
embarrassment,  as  State  banks  entering  the  system  will  of 
course  be  required  to  meet  the  requirements  of  the  later  law 
as  it  has  just  been  summarized.  Another  oddity  that  is 
worthy  of  notice  is  that  the  Comptroller  of  the  Currency 
does  not  requii'e  a  bank,  originally  oi'ganized  with  a  small 
capital  in  a  small  city,  to  increase  its  capitalization  to  a  larger 
amount  with  the  growth  in  the  city's  population.    It  is  thus 


44    OPERATION  OF  THE  NEW  BANK  ACT 

possible  that  in  some  cases  a  State  bank  may  be  refused 
membersliip,  although  it  has  a  larger  capital  than  some  of 
the  national  banks  in  the  same  city. 

Reserve  Requirements  for  Members. — In  Section  19, 
the  Act  definitely  specifies  the  amount  and  location  of  the 
reserves  for  "every  subscribing  member  bank,"  but  states 
nothing  as  to  the  kinds  of  money  that  may  be  used  for  that 
purpose.  National  banks  will,  of  course,  be  required  to 
comply  with  the  present  requirements  and  may  employ 
only  specie  and  legal  tender.  Section  9  requires  that  State 
banks  must  comply  with  the  administrative  provisions  cov- 
ering reserve  requirements,  which  may  be  prescribed  by 
the  organization  committee  or  by  the  Federal  Reserve  Board. 
The  amount  of  the  reserves  is,  of  course,  definitely  stated, 
being  the  same  as  for  national  banks ;  but  the  kinds  of  money 
which  may  be  used  by  the  State  banks  as  a  part  of  their 
reserve  is  the  important  problem  to  be  solved.  Since  the 
State  banks  have  in  the  past  used  national  bank  notes,  the 
Federal  Reserve  Board  may  see  fit  to  allow  this  custom  to 
continue,  although  there  is  no  assurance  that  it  will  do  so. 

Miscellaneous  Provisions. — Miscellaneous  provisions  of 
the  National  Bank  Act  that  are  referred  to  under  the  third 
group  of  requirements  for  eligibility  may  also  be  sum- 
marized. "The  total  liabilities  of  any  person,  company, 
corporation  or  firm  to  any  national  bank  for  money  bor- 
rowed is  limited  to  one-tenth  of  the  bank's  capital  and  sur- 
plus," with  the  further  stipulation  that  the  total  of  such 
liabilities  shall  in  no  event  exceed  thirty  per  cent  of  the 
capital  stock  of  the  bank  and  that  "the  discount  of  bills 
of  exchange  drawn  in  good  faith  against  actually  existing 
values,  and  the  discount  of  commercial  or  business  paper 
actually  owned  by  the  person  negotiating  the  same,  shall  not 
be  considered  as  money  borrowed."  A  national  bank  is 
also  forbidden  to  make  loans  or  discounts  on  the  security 
of  its  own  capital  stock  or  to  purchase  the  same,  except  to 
secure  a  debt  previously  contracted  in  good  faith,  nor  shall 
it  ever  declare  dividends  "to  an  amount  greater  than  its 
net  profits  then  on  hand,  deducting  therefrom  its  losses  and 


OWNERSHIP  45 

bad  debts."  All  of  these  restrictions  are  imposed  upon 
State  banks  that  become  members.  Since  they  are  pro- 
visions usually  found  in  the  State  laws  and  are  the  ones 
proper  for  most  banks  to  observe,  there  is  no  reason  to  feel 
that  they  involve  undue  hardships. 

Just  what  additional  regulations  may  be  prescribed  by 
the  Federal  Keserve  Board  to  govern  the  actions  of  State 
bank  members,  it  is  impossible  to  forecast.  The  new  act  enu- 
merates Sections  5198,  5200,  5201,  5208,  5209,  5211,  5212 
and  5213  of  the  Revised  Statutes  as  applicable  to  State  bank 
members.  Some  of  these  sections  cover  provisions  already 
explained  and  the  remainder  impose  penalties  for  the  taking 
of  unlawful  interest,  for  falsely  certifying  checks,  for 
embezzlement,  abstraction  and  misapplication  of  funds,  false 
entries,  etc.  Reports  of  the  kind  now  made  to  the  Comp- 
troller of  the  Currency  by  the  national  banks  are  also  re- 
quired. In  short,  it  may  be  said  that  State  banks,  to  be 
eligible,  must  meet  the  most  important  of  the  requirements 
now  imposed  upon  national  banks. 

In  some  cases  the  statutes  under  which  the  State  banks 
were  organized  make  it  impossible  for  them  to  join  the 
system.  Thus  in  New  York  and  in  a  few  other  States  the 
banks  are  not  allowed  to  own  the  stock  of  other  banking 
institutions.  This  would  prevent  the  ownership  of  the  stock 
of  the  Federal  reserve  banks,  and  apparently  the  ditlficulty 
can  be  surmounted  only  by  a  change  in  the  State  law. 

The  statement  in  Section  2  of  the  Act,  that  the  applica- 
tion may  be  made  "witliin  sixty  days"  (by  February  22, 
1914),  might  be  interpreted  to  mean  that  later  applications 
by  State  banks  would  be  refused,  but  the  wording  in  the 
first  paragraph  of  Section  9  seems  to  indicate  that  this  is 
not  the  case,  thus  allowing  entrance  by  State  banks  whon- 
ever  they  soe  fit  to  apply.  As  a  national  bank  may  give  up 
its  charter  and  incorporate  as  a  State  bank  it  is  thus  pos- 
sible, though  perhaps  not  advisable,  for  any  bank  by  this 
method  to  remain  out  of  the  system  uTitil  thero  is  oppor- 
tunity to  observe  its  operation. 

Stock  Subscriptions. — Application  having  been  made 


4C         OPERATION  OF  THE  NEW  BANK  ACT 

and  accepted,  the  bank  mnst,  after  thirty  days'  notice  from 
the  organization  committee  or  the  Reserve  Board,  subscribe 
to  the  capital  stock  of  the  reserve  bank  in  its  district  to  an 
amount  equal  to  six  per  cent  of  its  own  paid-up  capital 
stock  and  surplus.  The  surplus  being  an  especially  varia- 
ble item,  occasional  new  subscriptions  or  withdrawals  and 
cancellations  of  stock  will  occur.  If  these  changes  are  fre- 
quent they  may  prove  to  be  annoying,  even  to  the  extent  of 
discouraging  an  increase  in  the  surplus.  The  purpose  of 
the  surplus  could  of  course  be  attained,  although  in  a  very 
unsatisfactory  manner,  by  allowing  a  growth  in  undivided 
profits.  It  is  also  to  be  observed  that  this  will  result  in  a 
fluctuating  capital  for  each  reserve  bank,  although  it  will,  on 
the  whole,  increase  with  the  growth  in  the  capital  invested 
in  banking  throughout  the  country. 

Time  of  Payments, — One-sixth  of  the  subscription,  or 
one  per  cent  of  the  combined  capital  and  surplus  of  each 
subscribing  bank,  must  be  paid,  not  at  the  end  of  the  thirty 
days  of  notice,  but  on  call  of  the  organization  committee 
or  the  Reserve  Board.  Another  one-sixth  is  due  within  three 
months  and  another  one-sixth  within  six  months  thereafter. 
The  balance  is  subject  to  the  call  of  the  Federal  Reserve 
Board. 

If  a  bank  has  been  admitted  to  membership  and  paid 
for  its  stock,  but  later  is  declared  insolvent  and  a  receiver 
is  appointed,  its  stock  in  the  reserve  bank  is  to  be  cancelled, 
without  impairment  of  its  liability,  and  all  cash  payments 
that  have  been  made  with  an  additional  payment  of  one- 
half  of  one  per  cent  per  month  from  the  period  of  the  last 
dividend,  are  to  be  applied  to  the  debts  of  the  insolvent  bank 
to  the  reserve  bank.  If  there  is  any  balance  then  remaining 
it  shall  be  paid  to  the  receiver.  Any  reduction  of  capital 
stock  by  a  member  bank  shall  make  necessary  a  reduction 
in  its  holdings  of  stock  in  the  reserve  bank,  and  the  repay- 
ment to  the  member  bank  of  that  portion  of  its  payment  on 
subscription. 

Form  of  Payments. — Payments  are  to  be  in  gold  or 
gold  certificates,  and  this  promptly  raises  the  question  of 


OWNERSHIP  47 

the  difficulty  that  may  be  experienced  in  securing  the  money 
without  injury  to  business.  The  bill  as  passed  by  the  House 
of  Representatives  specified  that  payments  were  to  be  in 
cash,  but  as  finally  enacted  the  requirement  is  gold  or  gold 
certificates.  "Cash"  has  a  broad  meaning  and  would  have 
made  possible  the  use  of  specie,  legal  tender,  national  bank 
notes  and  perhaps  even  checks  and  drafts.  The  final  word- 
ing is  very  definite,  but  still  leaves  several  points  open  for 
consideration. 

The  gold  payments  for  stock  subscriptions  must  be 
drawn,  directly  or  indirectly,  from  the  cash  reserves  in  the 
vaults  of  the  banks.  On  October  21,  1913,  the  actual  amount 
of  cash  held  by  the  country  banks  was  almost  eight  pei  cent 
of  their  deposits,  while  the  law  requires  them  to  hold  only 
six  per  cent.  Doubtless  this  excess  Avas  held  because  needed 
by  the  banks,  for  a  reserve  agent  would  have  been  willing 
to  pay  two  per  cent  interest  on  it.  This  means  that  for  the 
initial  payments  and  perhaps  for  all  payments  (unless  re- 
serve requirements  are  lowered  in  time  to  be  of  assistance) 
the  country  banks  may  find  it  necessaiy  to  draw  upon  their 
accounts  with  other  banks.  This  seems  all  the  more  pos- 
sible since,  beginning  with  the  passage  of  the  Act,  the 
national  banks  are  not  allowed  to  count  the  redemption 
fund  in  Washington  as  a  part  of  their  reserves,  and  in  some 
cases  it  may  even  be  necessary  to  increase  the  supply  of 
cash  in  the  vaults  of  the  banks.  The  country  banks  will 
not  gain  by  lowering  their  accounts  in  reserve  cities  below 
the  amount  they  may,  until  the  expiration  of  three  years, 
count  as  part  of  their  reserves,  but  if  they  draw  on  any 
excess  above  that  amount,  they  will  throw  the  burden  of 
securing  the  cash  on  the  shoulders  of  the  banks  in  the 
reserve  and  central  reserve  cities.  Since  reserve  city  banks 
are  for  the  most  part  in  a  position  to  do  so.  they  will  prob- 
ably draw  upon  the  central  reserve  city  banks,  thus  making 
the  problem  one  to  be  met  by  New  York,  Chicago,  and  St. 
Louis.  Inasmuch  as  Chicago  and  St.  Tjouis  keep  consider- 
able sums  in  New  York,  that  city  may  feel  the  strain  more 
than  nnv  other.    To  the  extent  that  the  countrv  and  reserve 


48        OrERATlON  OF  THE  NEW  BANK  ACT 

city  banks  have  money  loaned  direct  ou  call,  they  may  call 
these  loans.  But  unless  the  brokers  to  whom  those  loans 
are  made  cease  their  operations  entirely,  they  must  seek 
accommodations  elsewhere.  It  is  customary  for  the  city 
banks  to  act  as  agents  for  the  out-of-town  banks  in  these 
transactions,  and  when  the  latter  call  their  loans,  they  are 
merel}'  taken  over  by  the  city  banks. 

If  this  method  should  continue  to  be  followed,  the  bur- 
den will  still  fall,  as  under  the  assumption  of  the  preceding 
paragraph,  upon  the  banks  in  the  reserve  and  central  reserve 
cities,  especially  upon  those  in  New  York.  The  remittance  by 
a  given  bank  will  probably  be  effected  by  drawing  upon  its 
account  in  the  reserve  or  central  reserve  city  with  an  order 
that  gold  be  shipped  direct  to  the  reserve  bank  of  its  dis- 
trict. Special  arrangements  must  be  made  to  secure  gold 
from  the  correspondents,  as  the  accounts  are  payable  in 
silver  or  greenbacks,  as  well  as  in  gold.  No  matter  from 
which  group  of  banks  the  cash  for  capital  payments  may 
finally  be  drawn,  gold  or  gold  certificates  are  the  form  in 
which  remittances  must  be  made.  If  the  bank  upon  which 
the  burden  falls,  lacks  that  particular  form  of  cash,  the  gold 
needed  must  be  secured  from  the  United  States  Treasury. 
This  may  readily  be  done  by  offering  the  other  fonns  of 
money  for  redemption  in  gold. 

DifEculty  in  Making  Payments. — These  references  to 
the  possibility  of  friction  in  securing  gold  to  make  the 
capital  payments  are  not  to  be  viewed  as  proof  that  the 
burden  of  making  the  pa^^nents  will  fall  entirely  upon  the 
banks  in  the  central  reserve  cities.  So  many  unknown  fac- 
tors enter  into  the  problem  that  positive  statements  on  the 
point  can  not  be  made,  at  least  not  until  after  the  more  care- 
ful analysis  given  in  later  chapters.  The  question  is  raised 
here  in  order  to  indicate  that  friction  in  raising  the  capital 
is  possible  and  to  point  out  the  ways  in  which  such  friction 
may  be  avoided.  The  following  suggestions  are  made  on 
the  assumption  that  all  of  the  national  banks  will  enter  the 
system.  If  any  do  not,  their  number  will  probably  be 
offset  by  the  State  banks  that  enter.    As  we  are  seeking  to 


OWNERSHIP  49 

show  only  the  minimimi  amount  of  shifting  of  funds  that 
may  be  expected,  this  assumption  seems  a  fair  one. 

On  October  21,  1913,  the  national  banks  of  the  country 
had  a  combined  capital  and  surplus  of  $1,785,705,285.  Sub- 
scriptions to  an  amount  equal  to  six  per  cent  of  this  would 
total  $107,142,317,  and  as  only  three  per  cent  is  to  be  paid 
in,  the  receipts  by  the  banks  on  capital  payments  will  be 
$53,571,158,  with  the  balance  due  on  call.  One-sixth  of  its 
subscription  must  be  paid  by  any  bank  within  any  given 
period.  For  all  of  the  banks  this  one-sixth  would  amount 
to  $17,857,052.  If  this  sum  should  be  called  for  at  any 
one  time  there  might  be  considerable  difficulty  in  making 
payments  without  injury  to  business.  It  has  been  suggested 
that  the  lowered  reserve  requirements  will  release  the  neces- 
sary cash  and  that  at  once  after  making  payment  the  mem- 
ber bank  may  receive  its  cash  back  again  by  rediscounting. 
However,  the  new  reserve  requirements  are  not  operative 
in  any  district  until  the  Secretary  of  the  Treasury  shall  have 
officially  announced  the  establishment  of  the  Federal  reserve 
bank  in  that  district.  It  is  specifically  provided  that  a 
reserve  bank  may  not  transact  any  business  except  that 
which  is  necessarily  preliminary  to  its  organization  until 
it  has  received  authorization  from  the  Comptroller.  Unless 
a  reserve  bank  may  be  considered  to  be  "established"  be- 
fore its  capital,  or  a  part  of  it,  has  been  paid  in,  the  lowered 
reserve  requirements  will  give  no  relief.  And  unless  the 
Comptroller  authorizes  the  transaction  of  business  before 
the  capital  has  been  paid  in,  subscribing  banks  may  not 
secure  a  prompt  return  of  their  funds  by  rediscounting. 
How  some  of  these  matters  will  be  interpreted  can  not  be 
foreseen,  but  in  any  event  it  will  be  important  to  accom- 
plish the  pajTuents  without  needless  friction.  Several  of  the 
provisions  of  the  Act  are  of  assistance  and  will  doubtless 
be  utilized. 

Ways  of  Avoiding  Friction. — It  is  to  be  noticed  that 
the  first  payment  is  due  not  on  any  fixed  date,  but  that 
within  thirty  days  after  notice  from  the  organization  com- 
mittee every  national  bank  is  refjuired  to  subscribe,  and  the 


50        OPERATION  OF  THE  NEW  BANK  ACT 

first  installment  is  "payable  on  call  of  the  Organization 
Committee  of  the  Federal  Reserve  Board."  These  calls 
need  not  be  issued  to  all  the  banks  at  the  same  time,  but 
may  be  distributed  over  as  long  a  period  as  may  be  desirable 
and  may  from  time  to  time  be  distributed  with  discretion  in 
different  sections  of  the  country. 

A  second  advantage  is  the  fact  that  it  will  be  possible  to 
set  some  of  the  reserve  banks  in  operation  earlier  than 
others.  All  of  the  districts  must  be  decided  upon  before  the 
exact  boundaries  of  any  of  them  can  be  determined,  but  it 
is  entirely  possible  to  organize  one  or  even  several  promptly 
and  begin  to  operate  them  before  requiring  all  of  the  capital 
payments  from  the  others.  Here  also  discretion  may  be 
employed  and  the  dates  for  beginning  operations  may  be 
judiciously  scattered. 

A  third  source  of  relief  is  the  fact  that  the  subscribing 
banks  are  not  required  to  make  payment  on  any  set  days  but 
merely  within  certain  periods  after  the  first  call.  Thus  the 
bank  may,  within  limits,  consider  its  own  convenience  as  to 
the  date  of  pajTuent. 

A  fourth  and  very  important  aid  will  doubtless  be  found 
in  the  power  of  the  Secretary  of  the  Treasury  to  deposit 
government  money  where  it  will  be  of  assistance.  After  the 
new  system  is  organized  he  may  deposit  the  general  fund  of 
the  Treasurj^  with  the  exception  of  the  redemption  fund, 
with  the  reserve  banks  or  with  member  banks ;  and  prior  to 
that  time  he  may,  of  course,  continue  his  present  designation 
of  national  banks  as  depositories.  With  perhaps  $150,000,- 
000  at  his  disposal  to  deposit  as  he  sees  fit,  he  may,  and 
doubtless  will  be,  of  tremendous  assistance  in  tiding  over 
any  difficulties  that  may  arise.  In  fact  it  would  probably 
be  entirely  safe  to  say  that  the  four  sources  of  relief  com- 
bined are  so  important  that  there  need  be  no  fear  whatso- 
ever of  any  monetary  stringency  in  meeting  the  pa^nnents 
on  subscriptions.  The  requirement  that  the  payments  must 
be  in  gold  is  a  very  valuable  one.  in  that  a  considerable 
supply  of  it  will  thus  be  furnished  to  the  reserve  banks  at 
the  very  start. 


CHAPTER  V 

Federal  Reserve  Banks 

Organization  ol  Reserve  Banks, — In  a  previous  chapter 
we  have  described  the  work  of  the  organization  committci; 
down  to  The  point  where  any  five  applying  banks  in  a  given 
district  are  designated  to  execute  a  certificate,  and  that  docu- 
ment is  filed  and  recorded  at  the  Comptroller's  office  in 
Washington.  This  brings  into  existence  the  reserve  bank  as 
a  corporate  body.  The  powers  conferred  upon  it  by  the 
terms  of  the  Act  are  to  be  found  in  Section  4  and  are  the 
usual  general  corporate  powers,  with  the  exception  of  the 
eighth  in  the  list,  which  will  be  later  considered.  Each 
reserve  bank  is  "to  have  succession  for  a  period  of  twenty 
years  unless  it  is  sooner  dissolved  by  an  Act  of  Congress,  or 
unless  its  franchise  becomes  forfeited  bv  some  violation  of 
law." 

Classification  of  Directors. — After  the  certificate  of 
organization  has  been  filed,  the  next  step  is  to  choose  the 
board  of  directors.  Each  reserve  bank  is  to  have  nine  direc- 
tors, each  holding  office  for  three  years,  and  divided  into  the 
three  classes,  A,  B,  and  C,  there  being  three  in  each  class. 
The  members  of  Class  C  are  to  be  appointed  by  the  Federal 
Reserve  Board.  All  must  have  been  for  at  least  two  years 
residents  of  the  district  for  which  they  are  appointed,  and 
none  of  them  shall  be  an  officer,  director,  emploj^ee  or  stock- 
holder of  any  bank.  One  of  this  class,  who  must  be  a 
"person  of  tested  banking  experience,"  is  to  be  designated 
as  chairman  of  the  board  of  directors  of  the  reserve  bank 
and  also  shall  be  known  as  "Federal  reserve  agent."  In 
the  latter  capacity  he  shall,  under  regulations  of  the  Reserve 
Board,  maintain  a  local  office  of  that  Board  and  act  as  its 
official  local  representative.  Pending  his  appointment  the 
organization  committee  shall  perform  his  duties.  Another 
member  of  Class  C  shall  also  be  of  tested  banking  experience, 

51 


52        OPERATION  OF  THE  NEW  BANK  ACT 

and  shall  be  designated  as  deputy  chairman  and  deputy 
Federal  reserve  agent  to  act  in  the  absence  or  disability  of 
his  principal. 

How  Directors  are  to  be  Chosen. — Directors  of  Classes 
A  and  B  are  to  be  chosen  by  the  member  banks.  Directors 
of  Class  A  are  to  represent  the  member  banks,  while  those 
of  Class  B  shall,  at  the  time  of  their  election,  be  ''actively 
engaged  in  their  district  in  commerce,  agriculture,  or  some 
other  industrial  pursuit,"  and  may  not,  while  directors  of 
the  reserve  bank,  be  officers,  directors  or  employees  of  any 
other  bank.  "No  Senator  or  Representative  in  Congress 
shall  be  a  member  of  the  Federal  Reserve  Board  or  an  officer 
or  a  director  of  a  Federal  reserve  bank. ' ' 

In  each  district  the  chairman  of  the  board  of  directors 
of  the  reserve  bank  (also  known  as  the  "Federal  reserve 
agent")  or,  pending  his  appointment,  the  organization 
committee,  shall  classify  the  member  banks  of  the  district 
into  three  groups,  each  group  containing,  as  nearly  as  pos- 
sible, one-third  of  the  total  number  and  consisting  of  banks 
of  similar  capitalization.  Each  group  shall  be  designated 
by  number. 

Balloting  for  Directors. — At  a  regularly  called  meet- 
ing of  its  board  of  directors  each  member  bank  shall 
elect  by  ballot  a  ' '  district  reserve  elector ' '  and  shall  certify 
his  name  to  the  reserve  agent.  These  electors  may  be 
chosen  from  any  source  since  there  are  no  limitations 
in  the  Act,  and  so  will  probably  be  officers  and  directors 
of  the  various  member  banks.  The  reserve  agent  will 
make  lists  of  the  electors  thus  chosen  by  all  the  banks 
in  the  three  groups  of  the  district,  and  transmit  one  list 
to  each  elector  in  each  group.  Each  member  bank  may 
nominate  a  candidate  for  Class  A  and  another  for  Class  B 
of  the  board  of  directors  of  the  reserve  bank,  a  list  of  these 
nominees  being  furnislied  to  each  elector  within  fifteen  days 
after  its  completion.  Within  fifteen  days  after  the  receipt 
of  this  list  of  nominees,  every  elector  shall  certify  to  the 
reserve  agent  his  first,  second  and  third  choices  for  direc- 
tors of  Class  A  and  Class  B,  respectively,  on  a  ballot  form 


FEDERAL  RESERVE  BANKS  63 

furnished  by  the  reserve  agent.  No  more  than  one  vote  may 
be  cast  by  an  elector  for  any  one  candidate.  Each  elector 
will  thus  name  six  men,  three  in  each  class. 

Any  candidate  with  a  majority  of  the  total  votes  cast  in 
the  column  of  first  choice  shall  be  declared  elected.  If  there 
is  not  found  to  be  a  majority  for  any  one  candidate,  the  votes 
for  such  candidates  found  in  the  column  of  second  choice 
shall  be  added  to  those  in  the  first  column.  If  there  is  still 
no  majority  the  votes  in  the  third  colimin  also  shall  be  in- 
cluded. It  is  possible  that  this  wdll  show  a  majority  for 
some  one  of  the  candidates.  However,  if  it  does  not,  a  w'ay 
out  of  the  difficulty  is  arranged  by  providing  that  when  the 
third  column  is  included,  the  candidate  having  the  highest 
number  of  votes  shall  be  declared  elected.  A  deadlock  in  the 
voting  will  probably  iicvci"  occur  under  this  arrangement. 

Determining  the  Rotation  of  Directors. — At  the  first 
meeting  of  the  full  board  of  directors  of  the  reserve  bank, 
the  directors  of  each  of  the  three  classes  shall  decide  upon 
the  term  of  office  of  each  of  their  own  number.  One  of  each 
class  will  retire  in  one  year,  one  in  two  years,  and  one  in 
three  years  from  the  first  of  January  nearest  to  the  date  of 
such  meeting.  Thereafter  each  new  director  shall  be  chosen 
for  three  years.  Vacancies  at  any  time  in  any  one  of  the 
three  classes  are  to  be  filled  in  the  same  maimer  as  in  the 
original  selection,  such  appointees  to  hold  office  for  the  unex- 
pired term  of  their  predecessors.  Compensation  to  the 
directors  may  be  provided  by  the  reserve  banks,  the  amount 
to  be  subject  to  the  approval  of  the  Reserve  Board.  An 
exception  to  this  rule  is  the  Reserve  agent  w'hose  compen- 
sation, paid  monthly  by  the  reserve  bank,  is  to  be  determined 
by  the  Reserve  Board.  A  reasonable  allow'ance  also  is  to  be 
made  for  all  necessary  expenses  of  directors  in  attending 
board  meetings.  All  salaries  and  expenses  of  directors  are 
to  be  paid  by  the  respective  reserve  banks. 

Directorate  Divided  into  Two  Groups. — The  board 
of  directors  of  the  reserve  bank  as  thus  chosen,  while  nom- 
inally divided  into  three  classes,  is  actually  made  up  of 
two  groups.    Class  C  represents  the  Federal  Reserve  Board, 


54        OPERATION  OF  THE  NEW  BANK  ACT 

while  Classes  A  and  B  represent  the  banks.  Class  A  pre- 
siunably  will  be  composed  of  officers  or  directors  of  member 
banks,  since  they  are  not  debarred.  Members  of  Class  B 
may  not  be  officers,  directors,  or  employees  of  any  bank, 
but  must  at  the  time  of  their  election  "be  actively  engaged 
in  their  district  in  commerce,  agriculture  or  some  other  in- 
dustrial pursuit."  If  connected  with  any  bank  at  the  time 
of  their  election  they  must  resign  their  positions,  but  since 
they  are  chosen  by  the  banks  and  may  in  the  past  have  been 
officers,  directors  or  employees,  it  is  evident  that  they  will 
represent  the  interests  of  the  banks  that  have  chosen  them. 
Since  also  at  least  two  of  Class  C  must  be  men  of  "tested 
banking  experience,"  it  is  apparent  that  the  majority  of 
the  directorate  of  each  reserve  bank  will  be  composed  of 
men  who  have  a  knowledge  of  banking  practice  or  will  be 
subject  to  the  instructions  of  those  who  do  have  such 
knowledge. 

Majority  of  Directors  Will  Be  Experienced  Bankers. 
— The  fact  that  a  majority  of  the  directors  of  each  reserve 
bank  will  be  men  experienced  in  banking  needs  emphasis. 
JMembers  of  Class  A  will  doubtless  continue  to  be  active  as 
directors  and  officials  of  their  own  banks.  As  such  they  wall 
be  in  constant  touch  with  the  problems  upon  which  they  will 
need  to  pass  in  their  capacity  as  reserve  bank  directors. 
Members  of  Class  B,  although  not  officially  connected  with 
any  bank,  will  be  thoroughly  familiar  with  the  different 
lines  of  business  in  their  own  communities.  It  is  because  of 
this  general  knowledge  of  business  and  commercial  condi- 
tions that  their  services  on  directorates  are  so  greatly  in 
demand.  The  duties  of  the  practical  banker  consist  largely 
of  passing  upon  the  quality  of  the  promissory  notes  and 
other  loans  placed  before  him.  In  such  work  the  bank's 
officers  need  and  secure  the  aid  of  business  men  of  the  com- 
munity who  make  up  the  bank's  directorate.  A  bank  official 
counts  upon  each  director  to  furnish  the  information  as  to 
conditions  in  some  line  of  business. 

It  is  men  of  this  type  that  are  to  serve  in  Class  B. 
During  their  period  of  service  they  may  not  be  officers,  direc- 


FEDERAL  RESERVE  BANKS  55 

tors,  and  employees  of  any  bank,  but  they  may  be  stock- 
holders. They  stand  midway  between  Class  C,  who  are 
appointed  by  the  government  and  presumably  represent 
the  people,  and  Class  A,  which  is  made  up  of  the  bankers 
themselves.  In  practice,  since  they  are  chosen  by  the 
bankers,  they  will  doubtless  reflect  the  views  of  the  bankers 
and  vote  with  them  on  questions  about  which  there  is  a 
difference  of  opinion.  As  two  out  of  the  three  members 
of  Class  C  are  to  be  of  "tested  banking  experience,"  the  nine 
members  of  the  directorate  of  each  reserve  bank  may  in- 
clude eight  who  are  experienced  in  banking.  This  will  be 
a  source  of  satisfaction  to  those  who  may  have  feared  that 
the  management  of  these  banks  might  be  placed  in  the  hands 
of  inexperienced  political  appointees.  On  the  other  hand, 
it  will  be  a  cause  of  concern  to  those  who  contend  that  the 
management  of  these  institutions  should  not  be  entrusted  to 
those  who  have  a  personal  interest  in  their  operation. 

Should  the  Bankers  Control  the  Board? — The  differ- 
ence of  opinion  on  this  point  suggests  a  question  of  much 
more  importance.  Has  the  law  been  so  framed  that  the 
technical  business  of  ])anking  is  placed  in  the  hands  of  men 
experienced  in  that  field  and  at  the  same  time  so  limited 
their  power  that  they  will  be  unable  to  endanger  the  inter- 
ests of  the  public?  The  first  half  of  this  question  has 
already  been  answered.  The  directors  of  the  reserve  banks 
are  to  be  experienced  bankers.  Routine  work,  upon  which 
the  actual  success  of  the  new  institutions  will  largely  depend, 
will  be  in  the  hands  of  experts  in  that  field.  Upon  their 
shoulders  has  been  placed  the  responsibility  for  sane,  conser- 
vative management. 

"We  are  not  yet  ready  to  answer  the  second  half  of  the 
question.  There  must  come  first  an  explanation  of  the 
resources  and  operations  of  the  reserve  banks  and  an 
analysis  of  the  personnel,  powers  and  duties  of  the  Federal 
Reserve  Board. 

Balance  of  Power  Between  Large  and  Small  Banks. — 
Another  important  consideration  is  that  of  1h(>  balance  of 
power  between  the  largo  and  tlie  small  l);niks.     .\s  a  people, 


56         OPERATION  OF  THE  NEW  BANK  ACT 

we  have  feared  concentration  of  power  among  the  large 
banks  and  heard  much  of  the  evil  influence  of  interlocking 
directorates  and  of  the  "Money  Trust."  It  is  obvious  that 
under  the  now  arrangement  there  will  be  a  tendency  to  break 
down  the  old  system  under  which  a  large  part  of  the  funds  of 
the  country  drifted  to  the  large  centers,  especially  to  New 
York.  Instead  we  shall  have  perhaps  twelve  centers,  each 
largely  separated  from  the  rest.  "Within  each  of  these 
districts,  however,  it  may  still  be  possible  for  the  larger 
member  institutions  to  maintain  control.  An  attempt  has 
bqen  made  to  prevent  this  by  dividing  the  banks  within  each 
district  into  three  groups  of  equal  size  for  the  purpose  of 
voting  on  the  choice  of  directors,  each  group  made  up  as  far 
as  possible  of  banks  of  like  capitalization.  This  machinery 
is  apparently  provided  with  the  intent  of  making  possible 
the  choice  of  representatives  from  each  of  the  groups — the 
large  banks,  the  small  banks  and  those  of  intermediate  capi- 
talization. How  successfully  it  might  work  if  the  Act  were 
entirely  clear  is  uncertain,  but  it  requires  great  faith  in  the 
efficacy  of  such  devices  to  prevent  domination  by  the  more 
powerful  interests  involved,  to  induce  the  belief  that  the 
larger  institutions  will  not  in  fact  determine  the  outcome  of 
each  election.  Unfortunately,  however,  the  plan  may  not 
receive  a  fair  trial,  for  although  the  provision  for  the  group- 
ing is  sufficiently  clear,  the  plan  for  casting  the  ballots  and 
for  counting  the  votes  makes  no  provisions  for  recognizing 
the  groups.  It  is  possible  that  rulings  may  be  made  later 
by  the  Federal  Eeserve  Board  that  will  abundantly  cover 
the  point.  Unless  this  is  done,  the  principle  introduced  in 
one  place  may  be  nullified  through  the  failure  to  observe  it 
elsewhere. 

Necessity  for  Branches. — With  eight,  ten,  or,  at  the 
most,  twelve  districts,  a  reserve  bank  will  not  be  able  to 
handle  conveniently  all  the  business  of  its  district  from  a 
single  office.  The  area  of  the  continental  United  States,  ex- 
eluding  Alaska,  is  2,383,006  square  miles,  or  an  average 
of  198,583  square  miles  for  each  of  twelve  districts.     The 


FEDERAL  RESERVE  BANKS  57 

prompt  transaction  of  business  between  the  reserve  banks 
and  their  members  will  be  facilitated  by  the  establishment 
of  branches.  These  are  provided  for  in  Section  3.  Each 
reserve  bank  is  directed  to  establish  branches  within  its 
district  and  permitted  to  establish  them  in  the  district  of 
any  other  reserve  bank  which  may  have  been  suspended. 
Each  branch  is  to  have  its  own  board  of  seven  directors, 
who  shall  operate  the  branch  under  rules  and  regulations 
approved  by  the  Reserve  Board.  Their  qualifications  are 
to  be  the  same  as  those  of  the  directors  of  the  reserve  banks. 
Four  are  to  be  chosen  by  the  reserve  bank  and  three  by  the 
Reserve  Board  and  each  may  hold  office  during  the  pleasure 
of  the  body  that  appointed  him.  The  reserve  bank  shall 
designate  one  of  the  directors  as  the  manager. 

Importance  of  Branches. — These  branches  are  of  veiy 
great  importance.  The  extent  to  which  they  may  be  used 
is  dependent  upon  the  will  of  the  parent  reserve  bank  of 
which  each  is  a  branch,  and  which  will  draw  up  the  regu- 
lations under  which  it  will  operate,  and  upon  the  Reserve 
Board  by  which  those  regulations  must  be  approved.  Just 
how  much  authority  and  responsibility  may  be  placed  upon 
them  is  a  matter  for  conjecture,  but  the  practice  in  other 
countries  suggests  the  possibilities  here.  The  Bank  of  Eng- 
land has  eleven  branches,  and  the  Bank  of  France  has  one 
hundred  and  twenty-eight  head  branches,  seventy-two  auxil- 
iary bureaus  and  three  hundred  and  twelve  agencies.  The 
Reichsbank  of  Germany  has  nearly  five  hundred,  of  which 
twenty  are  head  offices  and  the  balance  sub-branches  and 
agencies;  the  functions  of  the  head  branches  are  the  same 
as  those  of  the  parent  institution,  while  the  work  of  the  sub- 
branches  and  agencies  is  limited  to  the  collection  of  bills, 
the  receipt  of  deposits,  etc.,  all  discounts  hq^ng  referred  to 
the  nearest  head  branch.  In  Canada  the  branches  of  the 
large  banks  are  very  numerous,  but  the  entire  Canadian 
system  is  so  different  from  our  new  one  as  to  make  any 
comparisons  of  little  value. 

Branches  Will  Prevent  Unfair  Advantages  to  City 
Containing  Main  Office. — Probably  a  considerable  amount 


58        OPERATION  OF  THE  NEW  BANK  ACT 

ol"  the  rivalry  among  the  various  cities  of  the  country 
has  been  due  to  a  failure  to  realize  that  numerous  branches 
may  be  established  and  that  each  of  these  branches  will 
have  its  own  directors  and  perhaps  transact  the  same  kinds 
of  business  as  the  head  office.  Communication  with  a  distant 
bank,  when  ordinary  accommodations  are  needed,  will,  in 
most  cases,  be  entirely  unnecessary.  With  numerous 
branches  there  need  be  no  long  delays  in  securing  redis- 
counts and  obtaining  notes. 

Resources  of  Reserve  Banks. — Having  descril)ed  the 
organization  of  the  reserve  banks  and  their  branches,  let 
us  next  analyze  the  nature  and  extent  of  their  resources, 
^n  general,  the  resources  originate  in  three  ways — payments 
on  capital  stock,  deposits  by  member  banks  and  deposits 
by  the  government.  The  exact  amount  of  each  of  these 
can  not  be  determined  with  accuracy.  "We  do  not  yet  know 
the  number  of  reserve  banks  and  how  much  capital  will  be 
subscribed  to  each;  hence  it  is  impossible  to  tell  how  much 
will  be  paid  into  each  from  these  sources.  The  reserve 
banks  are  to  hold  a  part  of  the  required  reserves  of  the 
member  banks,  but  the  amount  which  each  will  hold  can  not 
be  determined  even  approximately  until  we  know  their  num- 
ber. Since  the  Secretary  of  the  Treasury  may  leave  govern- 
ment moneys  in  the  Treasury  of  the  United  States  or  place 
them  in  reserve  banks  or  member  banks  at  his  discretion,  it 
is  hard  to  calculate  the  amount  of  resources  available  from 
this  direction.  'Bince,  moreover,  he  may  distribute  them 
among  the  reserve  banks  in  such  proportions  as  he  sees  fit, 
the  problem  is  still  more  complicated. 

If  we  proceed,  however,  on  our  previous  assumption  that 
all  of  the  national  banks  and  none  of  the  State  banks  will 
enter,  assume  ^Iso  that  the  Secretary  of  the  Treasury 
will  distribute  all  of  the  public  funds  equally  among  the 
reserve  banks,  and  finally  infer  that  the  maximum  number 
— twelve — will  be  established,  what  would  be  their  average 
strength?  Without  presenting  in  detail  at  this  point  the 
method  by  which  the  extent  of  each  class  of  resources  of  the 
reserve  banks  can  be  estimated,  it  may  be  stated  that  the  total 


FEDERAL  RESERVE  BANKS  59 

cash  resources  of  the  entire  number  of  regional  banks  will 
probably  be  between  $420,000,000  and  $672,000,000.  This 
would  give  to  each  of  twelve  an  average  of  from  $35,000,000 
to  $56,000,000. 

Necessity  for  Careful  Districting. — In  an  earlier  chap- 
ter reference  has  been  made  to  the  difficulty  of  determining 
the  boundaries  of  the  districts.  This  calculation  pictures 
very  clearly  one  phase  of  the  problem.  If  all  of  the  national 
banks  and  only  the  national  banks  enter,  the  total  paid-in 
capital  of  all  of  the  reserve  banks  will  be  only  $53,571,158.57 
and  their  total  cash  resources  no  more  than  about 
$672,000,000.  The  average  capital  of  each  would  thus  be 
$4,464,263.21  and  the  average  cash  resources  about 
$56,000,000. '  This  paid-in  capital  of  $4,464,263.21  implies, 
of  course,  a  subscribed  capital  of  twice  that  sum,  or 
$8,928,526.42  for  each.  In  order  to  secure  at  least  this 
amount  for  each  district  care  must  be  exercised  not  to 
enlarge  one  at  the  expense  of  the  rest,  unless  the  public 
are  to  be  asked  to  supplement  bank  subscriptions  in  some 
sections  of  the  country.  Yet  if  some  of  the  districts — for 
example,  that  in  which  New  York  City  is  located — are  very 
small  in  area,  the  reserve  banks  of  those  districts  will  be 
far  smaller  in  capital  and  aggregate  resources  than  many 
of  the  member  banks. 

The  national  banks  of  a  district  including  only  New  York 
State  would  contribute  a  paid-in  capital  of  $10,326,506.50, 
or  nearly  one-fifth  of  the  amount  that  can  be  secured  from 
the  entire  country.  If  tlie  area  of  the  district  be  restricted 
to  New  York  City  (not  including  Brooklyn),  the  paid-in 
capital  of  the  reserve  bank  would  amount  to  $7,479,150,  or 
about  one-seventh  of  the  total  amount  available.  Compared 
with  the  $50,000,000  capital  and  surplus  of  the  National 
City  Bank,  which  will  be  a  member  bank,  or  the  capital 
and  surplus  of  $25,000,000  of  the  First  National,  the  $17,- 
000,000  of  the  Hanover  National  and  the  $10,000,000  of  the 
Chase  National  of  New  York,  the  stoekholdei-s'  contributions 
to  the  regional  lianks  appear  pathetically  inade<|uat(\ 

Possibility  of  Failure  of  a  Reserve  Bank. — We  can  not 


60        OPERATION  OF  THE  NEW  BANK  ACT 

avoid  considering  the  possibility  of  the  failure  of  a  member 
bank  larger  than  the  reserve  bank  of  its  district.  It  is  not 
difficult  to  see  that  the  failure  of  such  a  large  institution  as 
the  National  City  Bank  of  New  York,  whose  resources  are 
$293,171,812.46,  would  place  the  reserve  bank  of  the  New 
York  district  under  a  very  heavy  strain.  The  seriousness 
of  this  is  relieved  by  two  considerations.  One  is  the  re- 
minder that  the  Bank  of  England  with  a  capital  and  rest 
(surplus)  of  £17,776,461  ($88,882,305)  and  total  resources 
in  both  issue  and  banking  departments  on  December  13, 
1913,  of  £115,981,198  ($579,905,990)  is  not  much  larger 
than  a  number  of  the  joint-stock  banks  of  Great  Britain. 
Thus  Lloyd's  Bank  has  total  resources  of  £104,830,193 
($524,150,965)  and  the  London  County  and  Westminster 
Bank  has  resources  of  £100,434,316  ($502,171,580). 

A  second  consideration  is  the  fact  that  each  reserve  bank 
has  resources,  from  which  it  may  secure  help,  that  is  not 
available  to  its  member  banks.  Its  right  to  secure  Federal 
reserve  notes  and  the  power  of  the  Federal  Eeserve  Board 
to  compel  other  reserve  banks  to  rediscount  for  it  are 
among  the  most  important.  ]\Ioreover,  as  time  passes  each 
reserve  bank,  if  the  system  is  a  success,  may  materially 
strengthen  its  position  by  the  accumulation  of  a  surplus. 

Summary  of  Powers  of  Reserve  Banks. — The  reserve 
banks  are  organized  with  the  hope  that  they  will  perform 
certain  very  important  functions.  Upon  their  work  depends 
the  success  or  failure  of  the  entire  system.  To  the  extent 
that  they,  under  the  direction  of  the  Federal  Reserve  Board, 
are  able  ' '  to  furnish  an  elastic  currency,  and  to  afford  means 
of  rediscounting  commercial  paper,"  the  improvements 
hoped  for  by  Congress  will  be  secured.  This  leads  us  from 
our  survey  of  their  resources  to  a  discussion  of  their  powers 
and  their  method  of  operation.  What  is  said  on  this  topic 
applies  both  to  the  banks  and  to  their  branches,  the  latter 
exercising  the  functions  that  may  be  allowed  them  under 
the  rules  and  regulations  set  forth  by  the  reserve  banks  and 
approved  by  the  Federal  Reserve  Board.    Only  a  brief  sum- 


FEDERAL  RESERVE  BANKS  61 

mary  need  be  given  at  this  time,  as  each  must  be  treated  in 
detail  in  later  chapters. 

Member  banks  must  deposit  a  specified  portion  of  their 
reserves  with  the  reserve  banks.  This  is  necessary  in  order 
to  secure  a  secondary  bank  reserve  that  is  liquid.  At  pres- 
ent, reserves*  of  this  sort  are  created  by  each  bank  accumulat- 
ing a  reserve  account  with  one  or  more  banks  in  the  large 
cities,  approved  by  the  Comptroller  of  the  Currency  for  this 
purpose,  these  approved  banks  being  known  as  reserve 
agents.  Competition  among  reserve  agents  has  resulted  in 
the  offer  of  interest  for  these  reserve  accounts,  two  per  cent 
being  the  rate  usually  paid. 

Will  the  Reserve  Banks  Pay  Interest  upon  Deposits? 
— Federal  reserve  banks  are  not  forbidden  by  the  Act  to 
pay  interest  on  deposits  of  member  banks,  but  it  does  not 
seem  at  all  certain  that  they  will  do  so.  Within  any  district 
there  can  be  no  competition  for  the  deposit  of  required 
reserves.  All  such  reserves  must  be  deposited  by  a  member 
bank  in  the  reserve  bank  of  that  district.  It  also  seems  prob- 
able, for  reasons  given  elsewhere,  that  the  reserve  banks  will 
have  no  motive  to  compete  with  other  institutions  to  secure 
deposits  from  members  in  excess  of  the  amounts  required 
for  reserve  purposes  since  they  will  ordinarily  not  be 
troubled  by  a  lack  of  funds.  It  may  be  that  some  members 
will  keep  extra  amounts  with  them  for  exchange  purposes, 
but  that  will  doubtless  be  due  to  their  own  self-interest  and 
not  because  the  accounts  are  definitely  solicited  by  the 
reserve  banks. 

If  there  is  any  doubt  of  the  ability  of  a  reserve  bank 
to  pay  regularly  the  cumulative  six  per  cent  dividend  to  the 
banks  owning  the  stock,  there  would  certainly  be  no  reason 
why  member  banks  should  desire  the  interest  payments, 
as  they  would  thus  be  adding  to  the  operating  expenses  of 
the  bank  and  lowering  their  own  dividend  returns.  In  the 
absence  of  any  prohibition  against  the  payment  of  interest 
on  deposits  and  in  view  of  the  fact  that  the  reserve  banks 
may  be  successfully  operated,  pressure  may  be  exerted  to 
secure  it.    This  brings  us  back  to  the  fact  previously  empha- 


62        OPERATION  OF  THE  NEW  BANK  ACT 

sized  that  the  management  of  the  reserve  banks  is  in  the 
hands  of  the  bankers  themselves.  Their  representatives 
constitute  a  majority  of  the  membership  of  the  board  of 
directors  and,  if  they  so  decide,  interest  may  be  paid  upon 
these  deposits.  The  great  central  banks  of  Europe  do  not, 
however,  pay  interest. 

Will  Government  Deposits  Draw  Interest? — Deposits 
may  be  made  by  other  reserve  banks,  but  only  for  exchange 
purposes.  Since  these  accounts  will  be  very  active  the  ques- 
tion of  interest  will  doubtless  not  arise,  but  the  question  of 
deposits  by  the  United  States  is  very  different.  Under  the 
Act  of  May  30,  1908,  "all  national  banking  associations 
designated  as  regular  depositaries  of  public  money  shall  pay 
upon  all  special  and  additional  deposits  made  by  the  Secre- 
tary of  the  Treasury  in  such  depositaries,  and  all  such  asso- 
ciations designated  as  temporary  depositaries  of  public 
money  shall  pay  upon  all  sums  of  public  money  deposited  in 
such  associations  interest  at  such  rate  as  the  Secretary'  of  the 
Treasury  may  prescribe,  not  less,  however,  than  one  per 
centum  per  annum  upon  the  average  monthly  amount  of 
such  deposits." 

This  requirement  is  not  altered  by  the  new  Act.  In 
the  future  the  Secretary  of  the  Treasury  may  use  his  dis- 
cretion in  depositing  United  States  money  with  reserve 
banks  or  member  banks.  Since  member  banks  will  still  be 
required  to  pay  interest,  he  will  certainly  be  tempted  to 
leave  the  funds  with  them  unless  the  reserve  banks  offer  simi- 
lar inducements.  Again  we  may  observe  that  European  prac- 
tice, with  one  or  two  minor  exceptions,  is  against  doing  this. 
Our  situation  will  be  different  in  one  very  important  par- 
ticular. After  the  payment  of  six  per  cent  cumulative 
dividends,  all  net  earnings,  with  certain  deductions,  are  to 
be  paid  to  the  United  States.  The  pav-ments  to  the  govern- 
ment thus  provided  for,  may  be  considered  sufficient  reason 
for  not  requiring  the  payment  of  interest  on  United  States 
deposits. 

Rediscounting. — An  important  feature  of  the  work  of 
the  reserve  banks  is  rediscounting.     Banks  needing  cash 


FEDERAL  RESERVE  BANKS        63 

may  take  such  of  their  assets  as  are  in  the  form  of  commer- 
cial paper  of  the  sorts  specified  by  the  Act  as  available  for 
the  purpose,  and  offering  this  for  discount,  obtain  funds 
from  the  reserve  banks.  These  funds  secured  by  the  process 
of  rediscountiug  may  be  either  in  the  form  of  a  checking 
account  with  the  reserve  bank,  or  in  cash.  The  account  may 
be  merely  the  reserve  account  which  the  member  bank  is  re- 
quired to  maintain,  or  it  may  be  such  excess  above  that  sum 
as  it  may  desire  for  exchange  purposes.  If  cash  is  secured, 
it  may  be  secured  in  one  of  several  forms ;  the  reserve  bank 
may  choose  to  deliver  specie,  greenbacks,  national  bank 
notes,  the  reserve  bank's  bond-secui'ed  notes  or  Federal 
reserve  notes.  Since  some  of  these  are  not  available  for 
use  as  reserves  bj^  member  banks,  especially  the  national 
banks,  the  bank  securing  them  may  promptly  present  them 
for  redemption  either  at  the  counter  of  the  reserve  bank 
itself  or  at  the  United  States  Treasury.  The  extent  to  which 
rediscountiug  will  be  practiced  and  Federal  reserve  notes 
issued  is  largel}^  a  matter  for  speculation  and  can  not  be 
predicted  with  any  approach  to  accuracy.  It  will  be  de- 
pendent, however,  upon  the  favor  with  which  American 
bankers  view  the  practice,  the  extent  of  their  need  for  such 
assistance,  the  amount  of  paper  of  the  acceptable  sort  which 
they  may  have  in  their  portfolios  when  the  need  arises,  and 
finally  the  promptness  and  ease  with  which  this  aid  can  be 
rendered. 

Banks  Must  Treat  Members  Fairly  and  Impartially, — 
Before  leaving  the  question  of  rediscountiug,  attention 
should  be  called  to  the  wording  of  a  paragraph  of  Section  i, 
which  declares  that  the  board  of  directors  of  a  reserve  bank 
shall  "administer  the  affaii's  of  said  bank  fairly  and  impar- 
tially and  without  discrimination  in  favor  of  or  against  any  < 
member  bank  or  banks  and  shall,  subject  to  the  provisions  of 
law  and  the  orders  of  the  Federal  Reserve  Board,  extend  to 
each  member  bank  such  discounts,  advancements  and  accom- 
modations as  may  be  safely  and  reasonably  made  with  due 
regard  for  the  claims  and  ilcmands  of  other  member  l)anks." 


04        OPERATION  OF  THE  NEW  BANK  ACT 

This  statemeut  was  introduced  because  of  the  fear  expressed 
by  many  witnesses  before  the  Senate  Committee  on  Banking 
and  Currency,  that  the  reserve  banks  might  be  tempted  to 
discriminate  in  granting  accommodations.  One  witness, 
Prof.  0.  M.  W.  Sprague  of  Harvard  University,  held  that 
such  power  was  of  great  importance  to  the  reserve  banks 
since  it  would  give  them  the  ability  to  force  member  banks 
to  adopt  sound  banking  methods  under  the  penalty  of  not 
being  accommodated  in  time  of  need.  Others  contended 
that  there  was  greater  reason  to  fear  that  this  power  would 
be  used  unfairly,  and  pointed  to  alleged  cases  of  discrim- 
ination by  clearing  house  associations  in  the  panic  of  1907 
and  at  other  times.  The  net  outcome  of  the  discussion  was 
the  insertion  of  the  provision  just  quoted. 

Power  to  Issue  Notes, — Power  to  issue  notes  is  closely 
connected  with  the  right  to  rediscount,  and  calls  for  only 
brief  treatment  at  this  place.  Probably  little  gold  or  lawful 
money  will  be  voluntarily  paid  out  by  the  reserve  banks. 
Self-interest  will  prompt  a  policy  under  which  they  will 
pay  out  forms  of  money  which  they  may  not  count  as  part 
of  their  own  reserves.  National  bank  notes  come  first,  but 
they  may  be  presented  at  Washington  for  redemption  in 
lawful  money  and  this  lawful  money  may  be  placed  in  re- 
serves, so  national  bank  notes  may  not  be  paid  out  over  the 
counter  to  any  considerable  extent.  The  bond-secured  notes 
of  other  reserve  banks  will,  of  necessity,  be  forwarded  for 
redemption.  Each  reserve  bank,  however,  will  eventually 
have  its  o^vn  bond-secured  circulation,  and,  as  is  the  case  at 
present  with  the  national  banks,  will  be  eager  to  keep  these 
notes  at  work.  Money  is  invested  in  the  bonds,  and  the 
greatest  profit  can  be  secured  on  the  investment  only  by 
keeping  the  notes  in  circulation.  Hence  they  will  be  pushed 
out  as  rapidly  as  possible.  Federal  reserve  notes  will  come 
next  whenever  it  is  necessary  to  guard  the  supply  of  specie 
and  legal  tenders.  The  reserve  bank  issuing  reserve  notes, 
however,  must  pay  interest  for  them  at  a  rate  to  be  estab- 
lished by  the  Federal  Reserve  Board,  a  fact  which  may  dis- 
courage their  issue  and  hurry  their  prompt  retirement. 


FEDERAL  RESERVE  BANKS  65 

Provisiou  was  made  in  prelimmary  drafts  of  the  bill 
for  the  rediscounting  by  reserve  banks  of  the  direct  obli- 
gations of  their  members,  but  this  right  is  not  included  in 
the  Act  as  passed.  Borrowing  by  this  method  has  been  very 
common  among  banks  and  could  be  accomplished  more  easily 
and  more  quickly  than  by  rediscounting. 

Open  Market  Operations. — "Open  market  operations" 
is  the  expression  used  to  describe  the  other  kinds  of  business 
to  be  performed  by  the  reserve  banks.  The  purposes  of  these 
operations  are  (1)  to  furnish  lines  of  investment  for  the 
funds  of  the  reserve  banks  when  not  employed  in  the  sort 
of  work  already  described,  and  (2)  to  make  possible  a  gen- 
eral control  of  market  conditions  by  the  reserve  banks. 
Discussion  of  these  operations  must  be  confined  to  a  special 
chapter  on  the  subject. 

Profits  of  Reserve  Banks. — Just  how  profitable  the 
reserve  banks  will  be  it  is  impossible  to  determine.  Compari- 
sons with  present  banking  institutions  in  the  United  States 
are  futile  because  there  are  so  few  points  of  similarity. 
They  will  differ  in  so  many  ways  from  the  central  banks  of 
Europe,  especially  in  their  inability  to  compete  with  the 
other  banks  of  the  country,  that  no  inferences  may  be 
drawn  from  foreign  experiences.  Any  earnings  "after  all 
necessary  expenses  of  a  Federal  reserve  bank  have  been  paid 
or  provided  for"  are  to  be  devoted  to  the  payment  of  an 
annual  six  per  cent  cumulative  dividend.  Net  earnings 
above  this  amount  are  to  "be  paid  to  the  United  States  as  a 
franchise  tax,  except  that  one-half  of  such  net  earnings  shall 
be  paid  into  a  surplus  fund  until  it  shall  amount  to  forty 
per  cent  of  the  paid-in  capital  stock  of  such  bank."  The 
accumulation  of  a  surplus  is  in  line  with  the  requirement 
that  national  banks  must,  in  a  similar  manner,  set  aside 
a  part  of  their  net  earnings  until  a  twenty  per  cent  surplus 
has  been  acquired.  That  a  larger  percentage  of  surplus 
should  be  required  of  the  reserve  banks  is  wise  because  of 
their  greater  importance  and  responsibility. 

The  Franchise  Tax. — How  large  the  receipts  of  the 
United  States  from  the  franchise  tax  may  be  it  is  impossible 
5 


66        OPERATION  OF  THE  NEW  BANK  ACT 

to  conjecture.  Whatever  its  size,  it  is  to  be  used,  in  the 
discretion  of  the  Secretary  of  the  Treasury,  either  (1)  to 
supplement  the  gold  reserve  held  against  outstanding  United 
States  notes,  or  (2)  to  reduce  the  outstanding  bonded  in- 
debtedness of  the  United  States  under  regulations  to  be 
prescribed  by  the  Secretary  of  the  Treasury.  Which  alter- 
native is  used  will  depend  in  part  upon  the  personal  opin- 
ions of  the  Secretary  and  in  part  upon  the  market  con- 
ditions for  United  States  bonds.  If  used  to  strengthen  the 
gold  reserve  against  United  States  notes  they  may  ulti- 
mately be  protected  by  a  one  hundred  per  cent  reserve  and 
be  merely  gold  certificates.  This  may  pave  the  way  to  their 
entire  elimination  from  our  monetary  system.  On  the  other 
hand,  a  Secretary  less  impressed  with  the  alleged  dangers 
of  inflation,  but  greatly  troubled  over  the  existence  of  a 
large  national  debt,  may  buy  in  the  outstanding  United 
States  bonds.  If  these  bonds  should  fall  in  price  this  would 
be  desirable,  both  because  the  bonds  could  be  purchased 
cheaply  and  because  of  the  importance  of  supporting  the 
market  for  the  sake  of  the  government's  credit.  Here,  as 
elsewhere,  in  the  Act,  verj'  broad  powers  are  conferred  upon 
the  Secretary  of  the  Treasury. 

Provision  for  Dissolution  of  Reserve  Bank. — If  a 
reserve  bank  should  be  dissolved  or  go  into  liquidation, 
any  surplus  remaining  after  the  payment  of  all  debts, 
dividend  requirements  and  the  par  value  of  the  stock, 
shall  be  paid  to  and  become  the  property  of  the  United 
States  and  used  like  the  franchise  tax.  The  success  of  the 
reserve  banks  depends  upon  the  cordial  cooperation  of  the 
member  banks,  the  ability  of  the  Federal  Reserve  Board  and 
the  discretion  of  the  Secretary  of  the  Treasury,  With  so 
many  unknown  factors,  predictions  are  useless.  If  the  fail- 
ure of  a  reserve  bank  should  occur,  the  district  in  which  that 
bank  is  located  would  not  be  without  aid,  for  at  once  the 
reserve  bank  of  one  or  more  of  the  other  districts  may 
establish  branches  there.  Thus  there  need  be  no  permanent 
inconvenience  because  of  a  lack  of  banking  accommodations. 


CHAPTER  VI 

The  Problem  of  Control  op  the  New  System 

Cooperation  in  Europe. —  Each  of  the  reserve  banks 
that  has  just  been  described  is  a  sort  of  central  bank  within 
its  own  district.  The  situation  is  not  entirely  unlike  that 
existing  in  Europe  where  each  central  institution  is  espe- 
cially concerned  with  the  problems  and  needs  of  its  own 
country,  but  where  there  is,  nevertheless,  a  considerable 
amount  of  cooperation  between  these  banks  when  necessary. 
In  1890,  when  the  great  firm  of  Baring  Brothers  failed  in 
London,  the  Bank  of  France  came  to  the  rescue  of  the  Bank 
of  England  with  a  large  amount  of  gold.  Aid  Avas  also 
given  by  the  Russian  Imperial  Bank,  and  with  this  outside 
assistance  England  successfully  met  the  crisis.  In  1907  the 
panic  in  the  United  States  threatened  disaster  in  Europe. 
We  turned  to  England  for  help,  and  our  difficulties  might 
have  meant  trouble  for  the  Bank  of  England  had  not  the 
Bank  of  France  again  given  aid.  Self-interest,  if  nothing 
else,  compels  these  institutions  to  assist  each  other.  The 
downfall  of  any  one  of  them  would  be  a  calamity  that  would 
involve  the  entire  world,  just  as  the  failure  of  any  large 
bank  in  one  of  our  cities  might  mean  the  failure  of  many 
others. 

Valuable  as  this  help  may  be,  it  is  not  always  given  will- 
ingly. Commercial,  political  and  financial  rivalry  makes 
complete  harmony  of  action  an  impossibility,  and  aid  is 
often  withheld  until  serious  trouble  has  developed  and 
heavj'  losses  have  been  incurred.  This  was  the  case  in  1907, 
when  relief  reached  us  only  after  we  had  suffered  severely. 
To  a  less  extent  it  was  true  in  November,  191. S,  when  wo 
lost  $14,000,000  in  gold  to  Canada,  and  yet  could  not  import 
gold  from  London  in  spite  of  our  heavv"  balances  there.  The 
onh'  shipment  of  gold  that  was  engaged  during  the  fall 
caused  an  immediate  rise  in  discount  rates  in  London  and 

67 


(>8        OPERATION  OF  THE  NEW  BANK  ACT 

resulted  in  the  prompt  resale  of  a  part  of  the  gold.  All 
further  efforts  were  discouraged  by  the  fear  that  a  rise  in 
discount  rates  abroad  might  depress  the  foreign  market  for 
our  securities,  perhaps  to  such  an  extent  that  a  large  volume 
of  them  would  be  forced  back  upon  us.  This  would  have 
driven  down  their  prices  in  our  markets,  made  the  issue  of 
new  securities  here  difficult,  if  not  impossible,  and  in  this 
waj'^  would  have  seriously  hampered  our  growth  and  develop- 
ment. 

Our  Free  Gold  Market. — Concerted  action  among  our 
banks  in  such  a  situation  was  difficult.  "Within  the  United 
States  the  condition  of  the  banks  has  been  far  from  satis- 
factory. The  reports  to  the  Comptroller  of  the  Currency 
showed  a  large  percentage  of  violations  of  the  reserve  re- 
quirements, and  the  weekly  statements  of  the  New  York 
Clearing  House  banks  showed  a  surplus  reserve  that  was 
low,  and  which  finally  became  a  deficit.  Interest  rates  rose, 
especially  on  call  loans,  and  the  loans  and  discounts  of  the 
banks  were  sharply  contracted.  Yet  under  our  system  there 
was  no  way  to  prevent  withdrawals  of  gold.  We  had  ex- 
ported merchandise  heavily  throughout  the  fall  months  and 
large  balances  were  due  us  from  London,  but  Canada  used 
her  large  deposit  account  with  the  New  York  banks  in  a 
way  that  intensified  our  difficulties.  Exporting  both  to  us 
and  to  England,  she  added  to  her  own  foreign  credit  bal- 
ances upon  which  she  had  a  right  to  draw.  In  addition,  she 
arranged  with  London  bankers  for  the  underwriting  of 
several  large  security  issues.  Instead  of  drawing  directly 
upon  these  large  foreign  accounts  to  get  cash  for  her  local 
needs,  she  followed  her  usual  practice  of  financing  the 
transaction  through  New  York.  The  details  have  not  been 
made  public,  but  it  seems  probable  that  she  sold  sterling 
exchange  in  New  York  and  then  drew  the  gold  she  needed 
from  the  New  York  banks. 

New  York,  for  the  reasons  already  given,  was  very  reluc- 
tant to  import  gold  from  London,  and  was  thus  in  a  helpless 
position.  Conditions  in  various  parts  of  the  world  contrib- 
uted to  make  the  difficulty  more  serious.    Bank  failures  in 


CONTROL  OF  NEW  SYSTEM  69 

ludia,  difficulties  in  Paris  in  connection  with  the  financing 
of  the  Balkan  War  and  the  impending  1,300,000,000  franc 
government  loan,  disturbances  in  Mexico  and  rumors  of 
over-expansion  in  Brazil,  Russia  and  elsewhere,  added  to 
the  precariousness  of  the  situation.  Withdrawals  from 
London  were  inadvisable,  if  not  impossible,  yet  we  could  not 
check  the  drain  to  Canada. 

The  Need  for  Control. — This  incident  is  merely  one  of 
the  most  recent  of  an  almost  countless  number  that  could  be 
recited,  all  showing  the  need  for  international  assistance  and 
cooperation,  but  also  indicating  clearly  the  helpless  condi- 
tion of  the  United  States.  One  country  will  aid  another, 
but  only  if  such  aid  can  be  given  without  intensifying  the 
local  strain,  or  if  a  refusal  to  grant  assistance  would  react 
harmfully.  Control  is  exercised  differently  in  the  various 
countries,  but  in  every  instance  it  resolves  itself  into  the 
ability  of  some  central  institution  to  set  in  operation  forces 
that  accomplish  the  end  desired.  Centralization  of  control 
makes  possible  a  continuity  of  policy,  a  supervision  of  inter- 
nal financing,  and,  when  necessary,  the  exercise  of  force 
to  accomplish  the  purposes  desired. 

In  the  United  States  this  is  lacking.  Cash  and  credits  are 
concentrated  to  a  considerable  extent,  so  much  so,  in  fact,  as 
to  give  rise  to  the  charge  that  a  "Money  Trust"  exists.  But 
no  matter  how  true  the  charges  of  a  control  of  credit  may  be, 
unanimity  of  action  among  the  banks  through  interlocking 
directorates  and  otherwise  is  not  sufficiently  complete  to 
handle  the  difficulties  just  described.  The  new  regional 
system  is  intended  to  meet  this.  Each  reserve  bank  will  be 
in  close  touch  with  business  in  its  own  district.  Each  will 
adjust  its  discount  rates  to  meet  the  local  need,  will  issue 
notes  as  they  are  demanded  by  commercial  conditions,  and 
will  continually  guard  against  inflation.  If  trouble  starts 
in  any  district  it  will  reach  the  other  districts  of  the  country 
only  through  the  reserve  banks.  In  other  words,  the  country 
is,  figuratively  speaking,  divided  into  compartments  that  are 
expected  to  be  almost  watertight.  Disaster  in  one  is  to  be 
shut  off  from  the  rest. 


70        OPERATION  OF  THE  NEW  BANK  ACT 

Yet  this  very  isolation  might  be  carried  too  far.  Even 
in  ordinary  times  one  section  of  the  country  may  need  the 
aid  of  another,  while  in  time  of  stress  such  aid  must  be 
secured  in  order  to  prevent  a  disaster  like  that  of  1907.  In 
Europe,  assistance  is  voluntarily  given  by  one  country  to 
another  and  largely  as  a  matter  of  self-interest.  We  are  to 
try  another  plan  in  the  hope  that  it  will  be  still  better, 
believing  that  within  a  single  country  each  part  should 
not  only  be  willing  to  help  the  rest,  but  if  the  need  is  great, 
should  be  compelled  to  do  so. 

The  Federal  Reserve  Board. — Our  new  law  creates  a 
body  to  be  known  as  the  Federal  Reserve  Board,  a  body  of 
seven  men,  with  very  broad  powers  of  supervision  and  con- 
trol. The  Secretary  of  the  Treasury  and  the  Comptroller 
of  the  Currency  are  to  be  members  ex  officio,  and  the  other 
five  are  to  be  appointed  by  the  President  of  the  United 
States,  by  and  with  the  advice  and  consent  of  the  Senate. 
Only  one  of  the  appointive  members  may  be  selected  from 
any  one  district,  and  the  President  in  his  appointments 
must  "have  due  regard  to  a  fair  representation  of  the 
different  commercial,  industrial,  and  geographical  divisions 
of  the  country,"  a  restriction  that  is  difficult  to  interpret 
accurately,  but  which  at  least  would  seem  to  prevent  the 
choice  of  two  men  from  the  same  city. 

The  five  appointive  members  of  the  Reserve  Board  are 
to  hold  office  for  ten  years,  unless  sooner  removed  for  cause 
by  the  President,  the  first  appointees  being  chosen  for  two, 
four,  six,  eight  and  ten  years  respectively.  All  of  them,  as 
well  as  "the  Secretary  of  the  Treasury,  the  Assistant  Secre- 
taries of  the  Treasury  and  the  Comptroller  of  the  Currency, 
shall  be  ineligible  during  the  time  they  are  in  office  and  for 
two  years  thereafter  to  hold  any  office,  position  or  employ- 
ment in  any  member  bank."  Two  of  the  appointive  mem- 
bers must  be  experienced  in  banking  or  finance.  One  of 
these  two  is  to  be  designated  as  governor  and  one  as  vice- 
governor  of  the  Reserve  Board,  the  governor  being  the  active 
executive  officer.  The  Secretaiy  of  the  Treasury  shall  be 
ex  officio  chairman  of  the  board.  Each  of  the  five  appointive 


CONTROL  OF  NEW  SYSTEM  71 

members  must  give  his  entire  time  to  the  duties  of  his  office. 
It  is  possible  to  change  the  majority  of  the  board  in  a  presi- 
dential term.  The  ex  officio  members  are  removable,  while 
the  term  of  one  other  expires  every  other  year.  Any  presi- 
dent can  thus  name  four  out  of  seven  members. 

Too  much  stress  can  not  well  be  placed  upon  the  impor- 
tance of  these  positions.  The  enumeration  later  of  their 
powers  and  duties  will  make  this  entirely  clear ;  but  enough 
has  already  been  said  to  justify  the  statement  that  this  body 
of  men  will  be  fully  as  important  a  group  as  the  Interstate 
Commerce  Commission,  and  will  rank  next  in  power  to  the 
Supreme  Court  of  the  United  States.  That  this  will  be 
recognized  by  the  President  and  the  Senate  there  is  no  doubt. 
That  the  honor  and  importance  of  the  positions  will  attract 
men  of  ability,  regardless  of  the  salary  attached,  seems 
equally  certain ;  and  in  these  considerations  lies  the  answer 
to  the  fear  that  the  men  chosen  may  be  merely  political 
appointees,  picked  for  services  rendered  to  their  party. 
The  choice  of  the  two  who  are  members  ex  officio  will  prob- 
ably continue  to  be  detennined  by  the  considerations  that 
prevail  in  the  selection  of  a  Cabinet  officer  and  the  head  of 
a  government  bureau.  Of  the  five  who  are  appointed,  the 
terms  of  two  normally  expire  during  a  single  four-year 
administration.  These  two,  with  the  Secretary  of  the  Treas^ 
ury  and  the  Comptroller  of  the  Currency,  will  constitute  a 
majority  of  the  Board  and  could  control  its  activities.  It  is 
thus  conceivable  that  other  than  the  highest  motives  might 
result  in  the  abuse  of  this  appointive  power.  The  safeguard 
is  in  the  good  judgment  and  integrity  of  the  President,  of 
the  Senate  and  of  the  appointees  themselves. 

Qualifications  for  Membership. — There  is  nothing  to 
prevent  the  appointment  of  one  or  more  bankers  to  this 
board,  provided  that  they  resign  their  positions  as  officers 
or  employees  of  member  banks  before  entering  upon  their 
new  duties,  and  are  willing  to  refrain  from  holding  such 
offices  for  at  least  two  years  after  their  term  of  service  on 
the  Reserve  Board  has  expired.  This  is  specifically  indi- 
cated in  Paragraph  2  of  Section  10,  and  auotlicr  paragraph 


72         OPERATION  OF  THE  NEW  BANK  ACT 

of  the  same  section  adds  that  "no  member  of  the  Federal 
Reserve  Board  shall  be  an  officer  or  director  of  any  bank, 
banking  institution,  trust  company  or  Federal  reserve  bank 
nor  hold  stock  in  any  bank,  banking  institution,  or  trust 
company ;  and  before  entering  upon  his  duties  as  a  member 
of  the  Federal  Reserve  Board  he  shall  certify  under  oath 
to  the  Secretary  of  the  Treasury  that  he  has  complied  with 
this  requirement."  Whenever  a  vacancy  occurs  among  the 
five  appointed  members,  other  than  by  the  expiration  of  the 
term  of  the  incumbent,  the  place  shall  be  filled  in  the  same 
manner  as  the  original  appointment,  the  appointee  to  hold 
office  for  the  unexpired  term  of  the  member  whose  place  he 
is  selected  to  fill.  The  President  of  the  United  States  may 
fill  such  vacancies  during  a  recess  of  the  Senate  by  granting 
commissions  which  shall  expire  thirty  days  after  the  next 
session  of  the  Senate  convenes. 

The  Reserve  Board  and  the  Banks. — It  is  very  evi- 
dently the  intention  of  Congress  that  the  membership  of 
the  Reserve  Board  be  divorced  as  fully  as  possible  from 
control  by  the  banks.  Not  only  must  they  not  be  bankers 
while  holding  office,  but  they  must  not  become  bank  officials 
for  at  least  two  years  after  their  terms  on  the  board  have 
expired.  In  the  past,  officials  of  the  United  States  Treasury 
Department  have  at  times  resigned  to  accept  important 
executive  positions  with  large  banks.  Under  the  circum- 
stances remarkably  few  accusations  have  been  made  that 
these  government  officials  have,  while  in  office,  been  influ- 
enced in  their  actions  by  the  prospects  of  later  remunerative 
employment.  In  the  future,  however,  such  contingencies 
are  to  be  carefully  avoided.  Officers,  directors  and  em- 
ployees of  banks,  whether  members  or  non-members,  must 
resign  such  positions  if  appointed  to  the  Reserve  Board  and 
stockholders  must  dispose  of  their  holdings.  Some  of  the 
decisions  that  must  be  made  by  the  board  may  vitallj^  affect 
the  earnings  of  the  banks  of  the  country,  even  though  they 
may  not  belong  to  the  new  system.  No  one  with  a  personal 
interest  in  the  banks  could  perform  his  duties  on  the  board 
without  prejudice.     The  presence  of  a  railway  official  on 


CONTROL  OF  NEW  SYSTEM  73 

the  Interstate  Commerce  Commission  would  be  objection- 
able because  he  would  be  compelled  to  decide  problems  in 
whose  solution  he  has  a  personal  or  official  interest.  It 
would  be  an  obvious  impropriety  for  a  Justice  of  the 
Supreme  Court  to  plead  on  either  side  of  a  case  brought 
before  that  tribunal  for  decision.  For  similar  reasons  the 
presence  of  a  banker  on  the  Federal  Reserve  Board  is  objec- 
tionable. That  body  must  often  make  decisions  that  may  not 
be  of  aid  to  the  bankers,  although  for  the  best  interests  of 
the  country. 

Foreign  Practice. — Unless  the  apparently  very  strict 
language  of  the  Act  is  modified  in  practice  or  by  the  courts, 
its  requirements  are  more  stringent  than  either  the  law  or 
the  practice  .in  other  countries.  In  Germany  there  are  no 
legal  restrictions  as  to  membership  on  the  Board  of  Direc- 
tors of  the  Reichsbank,  and  in  practice  the  directors  are 
hankers,  merchants,  landlords  and  manufacturers.  Of  the 
eighteen  members  of  the  General  Council  of  the  Bank  of 
France,  there  are  restrictions  placed  on  the  choice  of  only 
eleven.  There  is  no  legal  restriction  as  to  the  class  from 
which  the  directors  of  the  Bank  of  England  may  be  selected 
except  that  they  must  be  "natural  born  subjects  of  England 
or  naturalized,"  but  in  actual  practice  the  selection  is  "con- 
fined to  those  who  are,  or  have  been,  members  of  mercantile 
or  financial  houses,  excluding  bankers,  brokers,  bill  discount- 
ers or  directors  of  other  banks  operating  in  the  United 
Kingdom." 

The  practice  of  limiting  selections  for  the  directorate  of 
the  Bank  of  England  to  men  not  engaged  in  hanking  is  often 
mentioned  as  one  that  we  should  copy.  The  mercantile  and 
financial  houses  from  which  its  directors  are  chosen  corre- 
spond somewhat  roughly  to  the  private  banks  of  the  United 
States.  They  deal  in  securities  and  act  as  guarantors  of 
paper.  The  bankers  who  are  excluded  are  those  connected 
with  the  joint  stock  banks  which  do  the  larger  part  of  the 
ordinary  commercial  banking  business  of  Great  Britain. 
Although  there  is  no  law  preventing  it,  the  fact  that  the 
Banlc  of  England  must  exercise  a  large  measure  of  control 


74        OPERATION  OF  THE  NEW  BANK  ACT 

over  their  business  and  that  it  actively  competes  with  them 
in  the  market,  has  created  a  sentiment  against  their  choice. 

The  Situation  in  the  United  States  not  Identical. — 
Our  new  legislation  contains  more  safeguards  than  either 
the  law  or  the  practice  abroad,  but  one  or  two  points  of  dif- 
ference must  be  noted.  The  powers  and  duties  of  the 
Federal  Reserve  Board  are  by  no  means  analogous  to  those 
of  the  directors  of  the  Bank  of  England.  The  latter  are 
responsible  for  the  conduct  of  an  ordinary  bank.  They  must 
scrutinize  paper,  pass  upon  the  granting  of  loans  to  par- 
ticular individuals  and  attend  to  the  other  multitudinous 
matters  that  are  a  part  of  daily  banking  routine.  The  Bank 
of  England  is  an  institution  dealing  daily  with  the  general 
public,  and  its  directors  are  the  officials  upon  whom  responsi- 
bility for  the  successful  conduct  of  this  banking  routine 
must  rest.  The  development  of  the  English  system  has, 
in  addition,  placed  upon  them  a  great  many  other  duties. 
As  we  have  already  indicated,  they  are  expected  by  the 
other  bankers  and  by  the  public  to  safeguard  the  financial 
interests  of  the  country  by  a  careful  oversight  of  the  con- 
duct of  the  other  banks. 

Under  our  new  law  the  duties  we  have  described  are  to 
be  divided.  The  routine  work  of  scrutinizing  paper  and 
passing  upon  individual  credit  is  assigned  to  the  nine  direc- 
tors of  each  reserve  bank.  One-third  of  them  are  to  be 
bankers,  another  one-third,  while  not  bankers,  are  to  be 
chosen  by  the  bankers  and  will  doubtless  be  familiar  with 
banking  matters,  even  though  not  actively  engaged  in  that 
business  at  the  time  of  their  choice.  The  other  three  direc- 
tors are  to  be  selected  by  the  Federal  Reser^^e  Board,  but 
two  of  them  must  be  men  of  tested  banking  experience.  It 
is  to  be  expected,  of  course,  that  the  officers  of  each  reserve 
bank  will  be  practical  bankers.  To  the  Reserve  Board  are 
assigned  the  powers  and  duties  of  supervision.  On  that 
board  must  be  men  who  understand  and  are  s;sTnpathetic 
with  banking  problems.  Some  of  them  should  have  been 
bankers  in  the  past,  but  none  of  them  should  remain  such 
while  members  of  the  Reser^^e  Board. 


CONTROL  OF  NEW  SYSTEM  75 

After  all,  as  is  urged  elsewhere  in  this  volume,  the  suc- 
cessful operation  of  this  new  law  will  be  dependent  upon 
two  factors.  The  more  important  of  the  two  is  the  customs 
and  habits  of  the  general  community  as  reflected  in  public 
opinion  and  sentiment.  Such  forces  are  of  slow  growth, 
but  when  developed  are  sufficiently  powerful,  even  in  the 
absence  of  legislation,  to  assure  the  success  or  failure  of 
any  social  or  political  institution.  Public  sentiment  is  the 
real  force  behind  the  Bank  of  England,  whose  operations 
are  but  slightly  controlled  by  statute.  Our  new  system  wiW 
for  years  lack  the  assistance  of  this  influence.  In  its  absence, 
we  must  rely  upon  the  second  factor,  which  is  adequate  and 
helpful  legislation.  For  this  reason,  as  well  as  for  others, 
the  prohibition  against  bank  membership  on  the  Reserve 
Board  seems  wise. 


CHAPTER  VII 

Powers  and  Duties  op  the  Federal  Reserve  Board 
Enumerated 

The  Powers  of  the  Board. — Turning  from  the  subject 
of  the  composition  of  the  Reserve  Board  and  the  qualifi- 
cations of  its  members,  the  next  question  is  that  of  its 
powers.  These  are  of  two  general  classes, — first,  those  that 
are  enumerated  under  twelve  headings  in  Section  11  of 
the  Act;  and,  second,  those  that  are  to  be  found  here  and 
there  throughout  the  Act  either  specifically  or  by  implica- 
tion. Both  are  summarized  in  the  following  digest,  the 
numbers  in  parentheses  after  each  indicating  the  section  of 
the  Act  in  which  it  may  be  found. 

1.  Readjust  districts  created  by  the  organization 
committee  and  create  new  ones  up  to  a  maximum  total 
of  twelve.  (2) 

2.  Call  for  payments  on  stock  subscriptions.  (2) 
(5) 

3.  Compel,  at  its  discretion,  any  national  bank 
to  cease  to  act  as  a  reserve  agent,  if  such  bank  fails  to 
accept  the  terms  of  the  Act  prior  to  Febniar^^  22, 
1914.   (2) 

4.  Direct  dissolution  proceedings  against  any 
national  bank  failing  to  become  a  member  or  to  other- 
wise comply  with  provisions  of  the  Act  before  Decem- 
ber 23,  1914.   (2) 

5.  Adopt  and  promulgate  rules  and  regulations 
governing  the  transfer  of  stock  of  the  Federal  reser\'e 
banks.   (2) 

6.  Approve  the  rules  and  regulations  governing 
the  operation  of  branches  of  the  reserve  banks,  and  to 
appoint,  with  power  of  removal,  three  of  the  seven 
directors  for  each  of  these  branches.   (3) 

7.  Supervise  under  the  law  the  extension  to  mem- 
ber banks  of  discounts,  advancements  and  accommoda- 
tions.  (4) 

76 


FEDERAL  RESERVE  BOARD  77 

8.  Designate  three  of  the  uine  directors  of  each 
reserve  bank,  specifying  one  as  chairman  and  "Fed- 
eral reserve  agent"  and  one  as  "deputy  Federal  reserve 
agent."  The  Reserve  Board  shall  also  fix  the  compen- 
sation of  the  Federal  resei've  agent,  and  must  approve 
the  compensation  provided  by  the  boards  of  directors  of 
the  reserve  banks  for  directors,  officers  and  employees. 

(^)  .  . 

9.  Receive     applications     for     membership     from 

State  banks  and  trust  companies  and  decide  upon  rules 
and  regulations  governing  their  admission,  subject  to 
the  provisions  of  the  Act.   (9) 

10.  Compel  any  member  bank  failing  to  comply 
with  the  Act  or  the  regulations  of  the  board  to  sur- 
render its  stock  in  a  reserve  bank.   (9) 

11.  Levy  semi-annual  assessments  upon  the  re- 
serve banks  for  its  estimated  expenses  during  the  suc- 
ceeding six  months,  together  with  any  deficit  carried 
forward.   (10) 

12.  Examine,  at  its  discretion,  the  accounts,  books 
and  affairs  of  each  resei"\'e  bank  and  of  each  member 
l)ank  and  require  such  statements  and  reports  as  it 
shall  deem  necessarj'.   (11) 

13.  Permit,  or  on  the  vote  of  at  least  five  members, 
require  one  reserve  bank  to  rediscount  the  discounted 
paper  of  another  at  a  rate  of  interest  to  be  fixed  by  the 
board.   (11) 

14.  Suspend  for  a  period  not  exceeding  thirty  days 
and  renew  such  suspension  for  periods  not  exceeding 
fifteen  days,  any  reserve  requirement  specified  in  the 
Act,  subject  to  certain  taxes  if  the  reserves  fall  below 
specified  minimum  percentages.   (11) 

15.  Authorize,  supervise  and  regulate  tbe  issue 
and  retirement  of  Federal  reserve  notes.   (11)   (16) 

16.  Add  to  the  existing  number  of  reserve  and 
central  reserve  cities,  reclassify  them,  or  terminate 
their  designation  as  such.   (11) 

17.  Suspend  or  remove  any  officer  nr  director  of 


78        OPERATION  OF  THE  NEW  BANK  ACT 

any  reserve  bank  for  cause  stated  to  the  official  removed 
and  to  the  said  reserve  bank.   (11) 

18.  Require  the  writing  off  of  doubtful  or  worth- 
less assets  upon  the  books  and  balance  sheets  of  reserve 
banks.   (11) 

19.  Suspend  any  reserve  bank  for  violation  of  the 
Act,  and  take  possession  of  and  administer  it  with  a 
view  either  to  liquidation  or  reorganization.   (11) 

20.  Require  bonds  of  Federal  reserve  agents  and 
regulate  their  safeguarding  of  collateral,  money,  etc. 

(11) 

21.  Exercise  general  supervision  over  the  reserve 
banks.   (11) 

22.  Upon  application,  grant  to  a  national  bank, 
when  not  in  contravention  of  State  or  local  law,  the 
right  to  act  under  rules  and  regulations  as  trustee,  ex- 
ecutor, administrator  or  registrar  of  stocks  and  bonds. 

(11) 

23.  Employ  attorneys,  experts,  assistants,  clerks 
or  other  employees  as  needed,  and  fix  their  salaries.  All 
such  appointments  may  be  made  without  reference  to 
civil  service  rules,  although  the  President  may  place 
said  employees  in  the  classified  service.   (11) 

24.  Approve  the  compensation  and  allowances 
voted  by  the  board  of  directors  of  each  reserve  bank  to 
its  representative  on  the  Federal  Advisorj'-  Council. 
(12) 

25.  Call  special  meetings  of  the  Federal  Ad^asory 
Council.   (12) 

26.  Determine  or  define  (subject  to  stipulations 
in  the  Act)  the  character  of  paper  eligible  for  discount 
by  member  banks.   (13) 

27.  Limit  the  amount  of  rediscounts  on  paper 
drawn  for  agricultural  purposes  or  based  on  live  stock 
and  with  a  maturity  not  exceeding  six  months,  to  a 
percentage  of  the  capital  of  the  reserve  bank  to  which 
application  for  the  rediscount  is  made.   (13) 

28.  Impose  restrictions,  limitations  and  regula- 
tions upon  rediscounts  by  the  reserve  banks.   (13) 


FEDERAL  RESERVE  BOARD  79 

29.  Draw  up  rules  and  regulations  for  the  guid- 
ance of  reserve  banks  in  the  purchase  and  sale  in  the 
open  market  of  bills,  acceptances,  cable  transfers, 
United  States  bonds  and  notes  and  certain  specified 
State  and  municipal  securities.   (14) 

30.  Review  and  determine  the  rate  of  discount  to 
be  charged  by  the  reserve  banks  for  each  class  of 
paper.   (14) 

31.  Authorize  the  establishment  of  correspond- 
ents and  agencies  of  reserve  banks  in  foreign  countries. 
(14) 

32.  Receive  through  the  Federal  reserve  agents, 
applications  for  Federal  reserve  notes,  and  at  its  dis- 
cretion grant,  in  whole  or  in  part,  or  reject  entirely 
such  applications.   (16) 

33.  Require  the  deposit  with  the  Federal  reserve 
agent  of  an  amount  of  collateral  equal  to  the  notes  thus 
applied  for  and  issued.  Additional  collateral  may  at 
any  time  be  required  to  protect  the  notes  already  is- 
sued.  (16) 

34.  Assign  to  each  reserve  bank  a  distinctive  letter 
and  serial  number  by  which  the  notes  issued  to  it  may 
be  identified.   (16) 

35.  Require  each  reserve  bank  to  maintain  in  the 
Treasury  of  the  United  States  a  redemption  fund  in 
gold  against  the  reserve  notes  issued  to  it.   (16) 

36.  Establish  the  rate  of  interest  to  be  paid  by 
each  reserve  bank  for  the  notes  it  receives  and  upon 
the  request  of  the  Secretary  of  the  Treasury  require 
each  reserve  agent  to  transmit  to  the  Treasury  of  the 
United  States  so  much  as  may  be  required  of  the  gold 
reserve  held  against  the  notes.   (16) 

37.  By  rule  fix  the  charges  to  be  collected  by  the 
member  banks  and  by  the  reser^-e  banks  for  their  ser- 
vices in  clearing  or  collecting  checks  and  drafts.   (16) 

38.  ^lake  and  promulgate  regulations  governing 
the  transfer  of  funds  between  resen-e  banks.   (16) 

39.  At  its  discretion  the  board  may  exercise  the 


80         OPERATION  OF  THE  NE\V  BANK  ACT 

i'uuctioiis  of  a  eleariug  lioubc  for  the  reserve  banks  or 
designate  a  resei^ve  bank  to  do  so.  (16) 

40.  Eequire  each  reserve  bank  to  act  as  a  clearing 
house  for  its  member  banks.   (16) 

41.  Require  the  reserve  banks  to  purchase  United 
States  bonds  securing  the  national  bank  circulation 
to  be  retired.   (18) 

42.  Approve  the  issue  of  new  three  per  cent  United 
States  bonds,  or  one-year  three  per  cent  gold  notes,  in 
exchange  for  the  two  per  cent  United  States  bonds  re- 
tired, or  the  issue  of  three  per  cent  bonds  in  exchange 
for  the  one-year  notes.  (18) 

43.  Permit  a  member  bank  to  act  as  the  agent  of 
a  non-member  bank  in  rediscounting.   (19) 

44.  Prescribe  regulations  and  penalties  (subject  to 
stipulations)  under  which  a  member  bank,  in  order  to 
meet  existing  liabilities,  may  withdraw  its  reserv^e  held 
with  a  reserve  bank.   (19) 

45.  Authorize  the  examination  of  State  banks  and 
trust  companies  by  State  authorities  instead  of  by 
Federal  examiners  and  also  direct  such  special  exami- 
nations of  them  as  it  may  see  fit.   (21) 

46.  Upon  recommendation  of  the  Comptroller  of 
the  Currency,  fix  the  salaries  of  all  bank  examiners. 
(21) 

47.  Approve,  directly  or  through  the  reserve 
agents,  regulations  by  any  reserve  bank  for  the  special 
examination  of  member  banks  within  its  district.   (21) 

48.  Require  a  reserve  bank  to  furnish  any  infor- 
mation as  to  the  condition  of  any  member  bank  in  its 
district.   (21) 

49.  Order  a  yearly  examination  of  each  reserve 
bank  and,  upon  joint  application  of  ten  member  banks, 
a  special  examination  of  any  reserve  bank.   (21) 

50.  Add  to  the  number  of  cities  in  which  national 
banks  shall  not  be  permitted  to  loan  on  real  estate.   (24) 

51.  Authorize  (subject  to  stipulations V the  estab- 
lishment by  national  banks  of  branches  in  foreign 
countries.   (25) 


FEDERAL  RESERVE  BOARD  81 

52.  Order  special  examinations  of  foreign  branches 
of  national  banks.   (25) 

53.  Approve  (subject  to  stipulations)  reductions 
in  the  capital  stock  of  national  banks  below  the  amount 
of  their  outstanding  circulation.   (28) 

In  addition  to  this  long  list  of  powers  of  the  Reserve 
Board  there  are  a  number  of  miscellaneous  specifications, 
some  of  which  are  quite  sweeping  in  their  nature.  Thus 
in  Section  11  (i)  the  Reserve  Board  is  empowered  to  "per- 
form the  duties,  functions  or  services  specified  in  this  Act, 
and  make  all  rules  and  regulations  necessary  to  enable  said 
board  effectively  to  perform  the  same." 

The  Extent  of  these  Powers. — There  has  been  much 
comment  upon  the  extent  of  these  powers.  They  are  un- 
doubtedly sweeping  and  may  be  iLsed  either  to  help  the 
operation  of  the  system,  or  in  such  a  manner  as  to  bring 
about  its  downfall.  The  list  just  enumerated  is  long,  and 
many  of  the  items  included  are  merely  routine  duties  as, 
for  example,  requiring  bonds  of  Federal  reserve  agents 
and  assigning  to  each  reserve  bank  a  distinctive  letter  and 
serial  number  by  which  the  notes  issued  to  it  may  be  iden- 
tified. Most  of  them  are  important  and  their  significance 
is  discussed  in  tbo  next  chapter. 

Limitations  on  the  Board. — Lest  this  long  list  should 
seem  to  imply  the  existence  of  a  body  of  men  whose  actions 
are  subject  to  no  control,  the  limitations  upon  their  powers 
and  the  duties  they  must  perform  must  be  examined.  Their 
power  is  great,  but  at  the  same  time  they  are  subject  to 
several  restraints,  two  of  which  are  very  important. 

One  of  the  restraints  upon  the  board  lies  in  the  power 
of  the  President  of  the  United  States  to  remove  any  of 
them  "for  cause."  Another  is  the  requirement  that  they 
must  publish  each  week  a  statement  showing  the  condition 
of  each  Federal  reserve  bank  and  a  consolidated  statement 
for  all  the  Federal  reserve  banks.  They  must  also  report 
to  Congress  tlie  salaries  of  bank  examiners  which  they  have 
fixed,  upon  the  recommendation  of  the  Comptroller  of  the 
Currency.  These  requirements  are  of  minor  importance 
6 


82        OPERATION  OF  THE  NEW  BANK  ACT 

and  in  no  way  impair  the  powers  essential  to  authoritative 
control. 

The  Power  of  the  Secretary  of  the  Treasury. — There 
are  only  two  limitations  of  any  considerable  importance. 
One  of  these  has  to  do  with  the  relations  of  the  Reserve 
Board  to  the  Secretary  of  the  Treasury  who  is  one  of  its 
members.  On  many  occasions  there  may  be  doubt  as  to  the 
border  line  between  the  powers  of  each  and  to  avoid  any 
chance  for  dispute  the  Act  specifically  states  in  Section  10 
that  "Nothing  in  this  Act  contained  shall  be  construed 
as  taking  away  any  powers  heretofore  vested  by  law  in  the 
Secretary  of  the  Treasury,  which  relate  to  the  supervision, 
management  and  control  of  the  Treasury  Department  and 
bureaus  under  such  department,  and  wherever  any  power 
vested  by  this  Act  in  the  Federal  Reserve  Board  or  the 
Federal  reserve  agent  appears  to  conflict  with  the  powers 
of  the  Secretary  of  the  Treasur)^  such  powers  shall  be  ex- 
ercised subject  to  the  supervision  and  control  of  the  Sec- 
retary. ' ' 

The  Federal  Advisory  Council. — The  second  impor- 
tant limitation  upon  their  powders  is  in  the  creation  of  the 
Federal  Advisory  Council,  composed  of  one  representative 
of  each  reserve  bank,  selected  annually  by  its  board  of 
directors.  This  council  of  bankers  is  to  meet  at  Washing- 
ton four  times  each  year,  and  oftener  if  called  by  the  Re- 
serve Board.  The  council  may  hold  such  additional  meet- 
ings as  it  sees  fit,  either  in  Washington  or  elsewhere,  and  may 
select  its  own  officers  and  adopt  its  owti  methods  of  proce- 
dure. The  only  control  w^hich  the  Reserve  Board  has  over 
this  body  is  in  its  approval  of  the  compensation  and  allow- 
ances voted  for  them  by  the  directors  of  the  reserve  banks. 
This  supervision  is,  of  course,  of  little  importance. 

Acting  as  a  body,  or  through  its  officers,  the  council  has 
power  to  do  three  specific  things,  and  the  significance  of 
each  is  dependent  upon  influences  concerning  which  no 
one  may  safely  predict.  These  powers  are  "(1)  to  confer 
directly  with  the  Federal  Reserv^e  Board  on  general  busi- 
ness conditions;  (2)  to  make  oral  or  wi'itten  representations 
concerning  matters  within  the  jurisdiction  of  said  board; 


FEDERAL  RESERVE  BOARD  83 

(3)  to  call  for  information  and  to  make  recommendations 
in  regard  to  discount  rates,  rediscount  business,  note  issues, 
reserve  conditions  in  the  various  districts,  the  purchase  and 
sale  of  gold  or  securities  by  reserve  banks,  open-market 
operations  by  said  banks,  and  the  general  affairs  of  the 
reserve  banking  system." 

The  Importance  of  the  Council. — A  careful  examina- 
tion of  this  grant  of  powers  makes  it  evident  that  the  influ- 
ence of  this  council  may  mean  much  or  little.  The  Act 
authorizes  it  to  confer,  to  make  representations,  to  call  for 
information  and  to  make  recommendations.  The  Reserve 
Board  is  not  required  to  furnish  the  information,  follow 
the  reconmiendations,  give  heed  to  the  representations  or 
do  anything  more  than  go  through  the  formality  of  holding 
the  conferences. 

From  this  situation  any  one  of  three  very  different  re- 
sults may  develop.  The  Reserve  Board  may  refuse  to  listen 
to  the  advice  proffered  by  the  council,  and  compel  it  to 
become  merely  a  formal  body  with  little  or  no  influence. 
The  council,  unable  to  compel  recognition  in  any  direct 
manner,  could  then  appeal  only  to  public  opinion  for  sup- 
port. On  the  other  hand,  the  council  may  dominate  the 
Resei've  Board,  and  through  this  dominance  gain  control 
of  the  entire  system.  Such  an  outcome  would  be  disastrous 
to  the  success  of  the  new  organization,  for  it  would  strike 
at  one  of  the  very  foundations  of  the  Act,  viz. :  that  the 
system  must  not  be  controlled  by  the  banks.  The  third 
possibility  is  the  one  to  be  desired.  It  is  to  be  hoped  that 
the  council  will  enter  earnestly  upon  the  task  of  furnishing 
complete,  helpful  and  disinterested  information  and  that 
the  Reserve  Board,  while  refusing  to  be  dominated,  will 
always  be  ready  to  analyze  carefully  the  information  fur- 
nished, and  to  act  upon  the  proffered  advice  if  it  is  good. 
It  is  also  to  be  hoped  that  the  board  will  freely  furnish  to 
the  council  such  information  as  may  be  a  proper  matter 
for  inquiry'  by  the  representatives  of  the  banks  which  are 
being  governed,  unless  the  disclosure  of  such  information 
is  contrary''  to  the  public  interest. 


84        OPERATION  OF  THE  NEW  BANK  ACT 

The  Reserve  Board  Must  Be  Supreme. — That  there 
will  be  diit'ereiiees  oi'  opinion  between  the  two  bodies  Is  in- 
evitable, but  no  question  can  be  raised  as  to  which  should 
be  supreme.  The  Advisory  Council  must  not  be  allowed 
to  review  the  decisions  oi"  the  Reserve  Board.  Such  a  situ- 
ation would  be  paralleled  if  a  board  composed  of  railway 
presidents  were  to  review  and  modify  the  rulings  of  the 
Interstate  Commerce  Commission.  Just  what  functions  may 
properly  be  perforaied  by  the  council  is  open  to  question. 
They  certainly  may  not  demand  information  that  the  board 
does  not  wish  to  furnish,  they  are  not  in  a  position  to  impose 
unwelcome  advice  on  the  board,  and  it  would  be  fatal  to  the 
success  of  the  entire  system  if  their  opinions  should  domi- 
nate directly  or  indirectly  the  decisions  of  the  board. 

In  the  new  system  there  is  a  proper  field  for  the  bankers 
and  another  for  the  board.  All  matters  that  have  to  do 
with  banking  routine  are  left  to  the  former.  They  scru- 
tinize paper  and  attend  to  all  of  the  details  in  managing  the 
reserve  banks.  The  Reserve  Board  is  given  powers  of  super- 
vision. The  relation  between  them  is  very  similar  to  that 
between  the  Interstate  Commerce  Commission  and  the  rail- 
ways of  the  country.  The  railroads  manage  their  own 
affairs  in  all  their  details,  subject  to  the  general  supem'ision 
of  the  commission.  The  bankers  will  manage  their  own 
banks  and  also  the  reserve  banks,  while  the  Reserve  Board 
will  supervise  this  management  in  the  interests  of  the  public 
of  which  the  bankers  themselves  are  a  part. 

Any  division  of  duties  between  these  two  bodies  which 
involves  a  yielding  of  power  by  the  Reserv^e  Board  will  be 
fatal.  The  only  safe  solution  is  for  the  Advisory  Council 
to  devote  itself  to  the  collection  and  presentation  of  facts 
and  the  furnishing  of  information,  but  never  advice,  except 
when  called  for.  The  outcome  will  be  determined  largely 
by  the  strength  of  the  leading  personalities  in  the  two  group.'^. 
especially  at  the  outset.  Precedents  either  way  may  mean 
much  for  the  future,  and  the  entire  spirit  of  the  system  will 
be  determined  bv  the  outcome. 


CHAPTER  VIII 
The  Poayers  op  the  Feder.vl  Reser\'e  Board  Analyzed 

The  Powers  Classified, — The  most  important  of  the 
powers  of  the  KeserYe  Board  may  be  discussed  under  six 
general  heads  in  the  follo^Yiug  order:  (1)  organization,  (2) 
rediscounts,  (3)  note  issues,  (4)  control  over  resen-e  banks, 
(5)  control  over  member  banks,  and  (6)  miscellaneous 
powers.  Prior  to  the  appointment  of  the  Reserve  Board 
(which  we  may  refer  to  hereafter  as  the  board)  the  organiza- 
tion committee  has  charge  of  the  organization  of  the  sys- 
tem. Since  the  former  will  take  up  the  work  of  the  latter 
we  need  attempt  no  close  distinctions  between  their  duties. 

Organizing  the  System. — The  districting  of  the  country- 
is  one  of  the  most  important  of  the  duties  to  be  perfonned. 
This  task  has  been  discussed  elsewhere  and  here  we  may 
merely  repeat  that  the  location  of  the  districts  will  have 
much  to  do  Avith  the  smooth  and  effective  working  of  the 
system.  If  they  are  so  arranged  as  to  aid  the  natural  move- 
ments of  business  and  finance,  the  success  of  the  new  law 
will  be  materially  aided;  if  the  reverse  shall  occur,  friction 
will  be  introduced  and  failure  may  follow. 

In  earrj'ing  on  the  work  of  organization  the  board  may 
determine  the  date  upon  which  the  first  call  for  stock  pay- 
ments may  be  issued  to  each  subscribing  bank  and,  by  the 
exercise  of  discretion  in  the  wise  distribution  of  these  calls, 
may  materially  lessen  difficulties  that  may  be  encountered 
in  securing  the  necessary  gold  without  injury  to  business. 
In  drawing  up  the  rules  and  regulations  governing  the 
admission  of  State  ])anks  to  membership,  important  assist- 
ance may  also  be  given.  It  is  in  the  ability  of  the  board  to 
force  prompt  action  by  the  national  banks  on  the  question 
of  membership,  however,  that  its  real  power  may  first  be 
clearly  shown.  The  use  of  coercion  may  be  rendercxl  entirely 
unnecessary  by  a  voluntary  movement  of  the  banks  to  enter. 


86        OPERATION  OF  THE  NEW  BANK  ACT 

but  this  very  williugness  may  be  due  to  the  power  of  the 
board.  National  banks  in  reserve  and  central  reserve  cities 
must  signify  prior  to  February  22,  1914,  their  willingness 
to  enter  the  system,  unless  they  wish  to  risk  the  loss  of  their 
reserve  accounts.  If  they  have  not  signified  their  intention 
of  joining  by  the  above  date,  they  may,  upon  thirty  days' 
notice,  be  required  to  surrender  their  reserve  deposits.  It 
seems  probable  that  in  most  cases  this  will  be  sufficient  to 
compel  their  entrance.  If  they  do  not  comply  within  one 
year,  dissolution  proceedings  may  be  directed  by  the  board. 
The  method  of  organizing  the  Federal  reserve  banks  has 
been  reviewed  at  length  in  a  preceding  chapter. 

Supervision  of  Rediscounts. — The  second  feature  of 
the  board's  W'Ork  is  that  of  supervision  over  rediscounting. 
The  Act  indicates  the  classes  of  paper  that  may  be  presented 
to  each  reserve  bank  by  its  members  for  rediscounting,  but 
inasmuch  as  a  complete  definition  of  the  commercial  paper 
referred  to  is  extremely  difficult,  there  is  left  with  the 
board  the  right  to  define  the  exact  meaning  of  the  general 
provisions  of  the  Act.  This  is  of  great  significance  to  many 
bankers  who  have  maintained  that  their  portfolios  lack  what 
is  ordinarily  kno\\Ti  as  commercial  paper.  Although  based 
upon  legitimate  commercial  transactions,  much  of  it  is  in 
its  form  not  acceptable  paper.  This  condition  is  due 
to  the  current  businass  practice  of  the  American  people, 
and  doubt  is  expressed  whether  the  board  will  be  able  so  to 
define  commercial  paper  as  to  make  rediscounting  possible 
for  many  banks.  The  rate  for  rediscounting  which  is  to 
be  charged  by  each  Federal  reserve  bank  is  subject  to  the 
review  and  determination  of  the  Reserve  Board,  Since 
a  majority  of  the  board  of  directors  of  each  reserve  bank 
will  be  chosen  by  the  bankers  themselves,  and  since  a  low 
rate  of  rediscount  is  to  the  advantage  of  each  member  bank, 
it  is  quite  possible  that  the  resen-e  bank  directorate  will 
hesitate  to  raise  the  rediscount  rate.  Thus  it  may  at  times 
be  advisable  or  necessary'-  for  the  Reserve  Board  to  insist 
on  a  higher  rate  than  the  one  suggested  by  the  reserve 
bank  itself.     This,  of  course,  gives  them  large  power. 


FEDERAL  RESERVE  BOARD  ANALYZED       87 

In  conneetiou  with  their  general  supervision  of  redis- 
counting  the  board  of  directors  of  each  reserve  bank  is 
instinieted  in  Section  4  to  "administer  the  affairs  of  said 
bank  fairly  and  impartially  and  without  discrimination  in 
favor  of  or  against  any  member  bank  or  banks,  and  shall, 
subject  to  the  provisions  of  the  law  and  the  orders  of  the 
Federal  Reserve  Board,  extend  to  each  member  bank  such 
discounts,  advancements  and  accommodations  as  may  be 
safely  and  reasonably  made  with  due  regard  for  the  claims 
and  demands  of  other  member  banks. ' '  This  is  intended  to 
insure  impartial  action  by  each  reserve  bank.  If  the  paper 
thus  rediscounted  at  the  reser^-e  bank  is  presented  to  the 
Federal  reserve  agent  for  the  purpose  of  securing  Federal 
reser\'e  notes,  the  paper  offered  as  collateral  may  be  accepted 
or  rejected  in  whole  or  in  part.  Also  the  board  has  a  gen- 
eral supervision  over  the  extension  (to  members)  of  ac- 
commodations that  are  authorized  by  the  Act.  These 
various  provisions  give  such  power  over  the  whole  practice 
of  rediscounting  that  they  may  dictate  its  general  operation, 
although  they  are  not  called  upon  to  examine,  except  per- 
haps in  unusual  cases,  each  piece  of  paper  that  is  presented. 
Doubtless  their  rulings  for  the  most  part  will  be  determined 
by  their  judgment  as  to  whether  there  has  been  an  over- 
extension of  credit  in  any  particular  district,  there  being 
left  to  each  reserve  bank  the  details  of  passing  upon  par- 
ticular commercial  paper. 

Supervision  of  Note  Issues. — The  third  part  of  their 
work  is  the  supervision  of  note  issues.  As  explained  in 
later  chapters,  the  present  national  bank  notes  are  grad- 
ually to  be  displaced  b.y  bond-secured  notes  of  the  reserv^e 
banks.  In  addition  there  ^Wll  be  issued,  as  occa.sion  arises, 
a  new  form  of  money  kno^vn  as  Federal  reser\'e  notes.  The 
issue  and  retirement  of  these  notes  are  to  be  under  the  gen- 
eral supen'ision  of  the  board.  Particular  powers  granted 
to  them  in  this  matter  are  the  right  to  accept  or  reject  all  or 
a  part  of  the  commercial  paper  that  is  offered  by  the  reserve 
banks  as  collateral  for  these  notes;  to  require  additional 
collateral  for  notes  alreadv  issued,  if  in  the  board's  judsr- 


88        OPERATION  OF  THE  NEW  BANK  ACT 

ment  such  additional  collateral  is  necessary;  to  demand 
that  a  part  of  the  forty  per  cent  gold  reserve  behind  these 
notes  be  kept  in  the  Treasury  of  the  United  States,  if  in 
their  judgment  this  is  wise;  and  to  fix  the  rate  of  interest 
which  each  reserve  bank  is  to  pay  for  the  notes  issued 
through  it.  This  right  to  accept  or  reject  collateral  or  to 
require  an  increase  in  its  amount  and  to  fix  the  rate  of 
interest  at  which  notes  may  be  issued,  gives  entire  control 
of  note  issues. 

Control  of  the  Reserve  Banks. — Fourth  in  the  list  of 
powers  of  the  Reser\'e  Board  is  their  control  over  reserve 
banks.  This  control  involves  a  general  supervision  and,  in 
particular,  gives  a  large  number  of  very  important  powers. 
Only  three  of  the  directors  of  each  reserve  bank  are  to  be 
appointed  by  the  board,  but  the  board  has  the  right  "to  sus- 
pend or  remove  any  officer  or  director  of  any  Federal  re- 
serve bank,  the  cause  of  such  removal  to  be  forthwith  com- 
municated in  writing  bj'  the  Federal  Reserve  Board  to  the 
removed  officer  or  director  and  to  said  bank."  It  seems 
hardly  necessary  to  say  that  such  a  power  places  the  reserve 
bank  almost  completely  under  the  control  of  the  Reserve 
Board.  They  may  remove  not  merely  the  directors  ap- 
pointed by  themselves,  but  upon  the  specification  of  cause 
may  remove  the  directors  that  have  been  chosen  by  the 
member  banks,  as  well  as  the  officers  of  that  institution. 

The  accounts  of  the  reser\'e  banks  may  be  examined  and 
these  banks  required  to  present  periodical  statements  and 
reports  to  the  board.  If  upon  examination  made  by  the 
examiners  of  the  Reserve  Board  any  assets  of  the  reser^-e 
banks  are  found  to  be  of  doubtful  value,  the  board  may 
require  that  they  be  written  off.  If  the  reserve  bank  vio- 
lates any  of  the  provisions  of  the  Act  the  Reserve  Board 
may  suspend  its  operations,  take  possession  of  it  and  admin- 
ister its  affairs  during  the  period  of  suspension,  and,  if 
deemed  advisable,  liquidate  or  reorganize  the  bank. 

Direction  of  Open  Market  Operations. — The  open 
market  operations  of  each  bank,  which  will  be  discussed 
later,  are  also  subject  to  the  superv^ision  of  the  Reserve' 


FEDERAL  RESERVE  BOARD  ANALYZED       89 

Board.  If  a  reserve  bank  wishes  to  maintain  a  foreign 
banking  account,  appoint  foreign  correspondents,  or  estab- 
lish agencies  abroad,  these  things  may  be  done  only  with 
the  consent  of  the  Reserve  Board  and  subject  to  its  regula- 
tions. If  conditions  warrant,  the  board  may  suspend  the 
reserve  requirements  of  the  reserve  banks,  allowing  them 
to  keep  less  than  the  amount  of  resei'\'e  required  by  the  Act, 
subject,  however,  to  certain  limitations  to  which  reference 
is  made  elsewhere.  If  one  of  the  reserve  banks  finds  itself 
in  difficulty  the  board  may  allow  another  bank  to  assist  it, 
or,  in  case  of  hasitation,  may  compel  such  assistance  to  be 
given,  by  requiring  a  particular  bank  to  rediscount  com- 
mercial paper  o\vned  by  the  distressed  institution.  The 
amount  of  the  redemption  fund  that  must  be  kept  by  the 
reserve  bank  against  the  reserve  notes  issued  through  it, 
is  to  be  fixed  by  the  Reserve  Board,  although  it  may  not  be 
less  than  five  per  cent  of  the  amount  of  such  notes  out- 
standing. 

Fixing  Collection  Charges. — Fully  as  important  as 
many  of  the  other  provisions  is  the  right  of  the  Reserve 
Board  to  fix  the  charges  for  collection  which  may  be  im- 
posed by  the  reserve  bank  for  the  service  rendered  in 
clearing.  Just  how  significant  this  will  be  is  to  be  deter- 
mined largely  by  the  board's  policy,  but  it  is  capable  of 
influencing,  to  an  almost  immeasurable  extent,  the  success 
or  failure  of  this  feature  of  the  new  system.  Ina.smuch  as 
the  board  may  also  require  any  one  of  the  reserve  banks  to 
act  as  a  clearing  house  within  its  o\ra  district,  the  ability 
to  dictate  concerning  collection  matters  is  evidently  one  of 
the  most  important  of  the  powore  conferred. 

Control  over  Member  Banks. — Not  only  does  the  Re- 
serve Board  have  a  great  measure  of  control  over  the  re- 
serve banks,  but  it  is  given  a  large  amount  of  control  over 
the  individual  member  banks.  The  right  to  suspend  resen'e 
requirements  imposed  by  the  Act  applies  not  merely  to  the 
reserve  of  the  reserve  banks  but  to  that  of  member  banks. 
The  section  granting  this  power  refers  to  "any  reserve 
requirement  specified   in   this   Act."     Granting  this  sus- 


90        OPERATION  OF  THE  NEW  BANK  ACT 

pension  may  be  the  salvation  of  a  bank  in  difficulty,  while 
refusal  to  grant  it  may  be  the  means  of  compelling  a  re- 
ceivership. The  board  may  at  its  pleasure  examine  the 
accounts,  books,  and  affairs  of  the  member  bank,  as  well 
as  those  of  a  reserve  bank,  and  require  statements  and 
reports  as  it  may  deem  necessary.  If  conditions,  in  the 
judgment  of  the  board,  seem  to  warrant  the  action,  the 
member  bank  may  be  allowed  to  withdraw  its  reserve  at  a 
reserve  bank  to  meet  its  existing  liabilities,  although  at  the 
same  time  the  member  bank  is  forbidden  to  continue  lending. 

Fixing  Collection  Charges  for  Member  Banks. — We 
have  already  noted  that  the  board  may  define  the  character 
of  paper  eligible  for  rediscount  by  member  banks  at  reserve 
banks,  and  may  fix  the  collection  charges  that  may  be  made 
by  the  reserve  bank  for  items  on  points  not  within  the  same 
district.  The  power  of  the  board,  however,  goes  further. 
The  charges  to  be  collected  by  member  banks  from  their 
patrons,  whose  checks  are  cleared  through  the  reserve  banks, 
are  to  be  fixed  by  the  Reserve  Board,  thus  giving  to  that  body 
the  power  to  determine  to  a  considerable  extent  the  earnings 
of  many  of  the  member  banks.  Still  further  the  board  may 
allow  a  member  bank  to  act  as  the  medium  or  agent  of  a  non- 
member  bank  in  securing  discounts  from  a  reserve  bank. 
It  may  authorize  the  establishment  by  member  banks  with 
a  capital  and  surplus  of  $1,000,000  or  more,  of  branches 
in  foreign  countries  or  in  dependencies  of  the  United  States. 
The  board  may  also  change  the  classification  of  the  reserve 
and  central  reserve  cities  of  the  United  States,  add  to  their 
number  or  terminate  the  designation  of  any  city  as  such; 
may,  at  its  discretion,  allow  a  bank  making  application 
therefor  to  act  as  trustee,  executor,  administrator  or  regis- 
trar of  stocks  and  bonds  under  such  rules  and  regulations 
as  the  board  may  prescribe,  pro\aded  that  such  grant  is  not 
in  contravention  of  State  or  local  law.  A  member  bank 
may  also  be  compelled  to  siirrender  its  stock  in  the  reserve 
bank. 

Miscellaneous  Powers. — A  number  of  miscellaneous 
powers  conferred  upon  the  board  are  difficult  to  classify, 


FEDERAL  RESERVE  BOARD  ANALYZED       91 

but  must  be  enumerated.  The  board  may  act  as  a  clearing 
house  for  the  reserve  banks  of  the  country ;  may  designate 
one  of  the  reserve  banks  to  act  as  a  clearing  house  for  the 
others;  and  may  require  each  reser\'e  bank  to  act  as  a 
clearing  house  for  its  member  banks.  It  will  supervise 
the  retirement  of  the  national  bank  notes  and  the  substitu- 
tion therefor  of  bond-secured  circulation  issued  by  the 
reser\'e  banks,  and  may  also  approve  the  retirement  of  this 
latter  circulation  and  allow  each  reserve  bank  to  secure 
three  per  cent  United  States  bonds,  without  the  circulation 
privilege,  or  one  year  three  per  cent  United  States  notes, 
also  without  the  circulation  privilege,  in  place  of  the  two 
per  cent  United  States  bonds.  The  board  is  required  to  fix 
the  salaries  of  bank  examiners  upon  the  recommendation  of 
the  Comptroller  of  the  Currency,  thus  changing  the  present 
system  of  fees  and  gratuities.  It  may  add  to  the  list  of 
cities  which  may  not,  under  the  terms  of  the  Act,  lend  to 
a  limited  extent  on  real  estate  security.  They  may  refuse 
to  member  banks  the  right  to  act  for  non-members  in 
applying  for  or  receiving  discounts  from  a  resen^e  bank. 

Great  Responsibility  on  the  Board. — Even  this  analysis 
of  the  powers  of  the  Reserve  Board  does  not  fully  indicate 
the  extent  of  authority  that  has  been  given  them ;  they  are 
subject  to  only  a  few  limitations.  The  powers  that  are 
granted  are  not  for  the  most  part  a  mere  specification  of 
routine  duty,  but  are  powers  in  whose  exercise  there  is 
imperative  need  for  discretion.  A  board  of  ability  may, 
through  wise  and  tactful  use  of  the  authority  bestowed  upon 
it,  render  almost  certain  the  success  of  the  system,  and,  on 
the  other  hand,  a  board  that  is  incompetent  or  not  fully 
alive  to  the  importance  of  its  problems  and  the  tremendous 
responsibilities  involved,  may  through  injudicious  action, 
through  sheer  carelessness,  or  through  lack  of  tact,  prevent 
the  successful  operation  of  the  new  system  at  the  verj'  start. 


CHAPTER  IX 

Rediscounts 

The  General  Need  for  Rediscounts  in  Crises. — One  of 

the  most  important  functions  which  the  Federal  reserve 
banks  will  perform  for  their  members  is  the  purchase  or 
rediscounting  of  commercial  paper  owned  by  them.  We 
have  seen  that  one  of  the  most  glaring  defects  in  our  bank- 
ing system  is  the  absence  of  any  agency  to  which  the  25,000 
banks  in  this  countrj^  can  turn  to  convert  their  assets  into 
money,  when  a  run  or  some  other  unforeseen  contingency 
places  them  under  an  unusual  strain.  Roughly  speaking, 
about  one-tenth  of  the  deposits  of  our  banks  are  held  in  the 
form  of  cash,  or  its  equivalent.  The  abihty  of  a  bank  to 
withstand  a  run  or  weather  a  panic  depends  upon  its  suc- 
cess in  disposing  of  the  commercial  paper,  collateral  loans, 
and  securities  owned,  which  represent  the  investment  of 
the  remaining  nine-tenths  of  its  deposits.  A  single  bank  in 
normal  times  could  generally  accomplish  this  feat,  but  in 
panic  times  when  every  bank  is  pressed  and  none  are  able 
or  willing  to  buy,  the  extent  to  which  assets  could  be  con- 
verted into  cash  has  been  very  small.  Briefly,  the  provi- 
sions relating  to  rediscount,  and  the  companion  provisions 
concerning  note  issues,  aim  to  create  an  adequate  and  re- 
liable source  to  which  the  banks  can  turn,  and  through  which 
a  large  part  of  their  assets  can  be  converted  into  money  to 
satisfy  depositors'  demands. 

Provisions  of  the  Act  Concerning  Rediscounts. — Sec- 
tion 13  of  the  Act  provides  that  "Upon  the  indorsement  of 
any  of  its  member  banks,  with  a  waiver  of  demand,  notice 
and  protest  by  such  bank,  any  Federal  reserve  bank  may 
discount  notes,  drafts,  and  bills  of  exchange  arising  out  of 
actual  commercial  transactions;  that  is,  notes,  drafts,  and 
bills  of  exchange  issued  or  drawn  for  agricultural,  indus- 
trial or  commercial  purposes,  or  the  proceeds  of  which  have 
92 


REDISCOUNTS  93 

been  used,  or  are  to  be  used,  for  such  purposes,  the  Federal 
Reserve  Board  to  have  the  right  to  determine  or  define  the 
character  of  the  paper  thus  eligible  for  discount,  within  the 
meaning  of  this  Act.  Nothing  in  this  Act  contained  shall  be 
construed  to  prohibit  such  notes,  drafts,  and  bills  of  ex- 
change, secured  by  staple  agricultural  products,  or  other 
goods,  wares,  or  merchandise  from  being  eligible  for  such 
discount;  but  such  definition  shall  not  include  notes,  drafts, 
or  bills  covering  merely  investments  or  issued  or  drawn  for 
the  purpose  of  carrying  or  trading  in  stocks,  bonds,  or  other 
investment  securities,  except  bonds  and  notes  of  the  govern- 
ment of  the  United  States.  Notes,  drafts,  and  bills  ad- 
mitted to  discount  under  the  terms  of  this  paragraph  must 
have  a  maturity  at  the  time  of  discount  of  not  more  than 
ninety  days :  Provided,  That  notes,  drafts,  and  bills  drawn 
or  issued  for  agricultural  purposes  or  based  on  live  stock 
and  having  a  maturity  not  exceeding  six  months  may  be 
discounted  in  an  amount  to  be  limited  to  a  percentage  of 
the  capital  of  the  Federal  reserve  bank,  to  be  ascertained 
and  fixed  by  the  Federal  Reserve  Board." 

What  Is  a  Rediscount? — What  is  a  rediscount?  It  is 
in  substance  very  similar  to  the  transaction  between  a  mer- 
chant who  holds  a  note  of  his  customer  and,  desiring  to 
convert  it  into  cash,  goes  to  his  bank,  endorses  the  note 
and  procures  its  discount,  the  proceeds  being  credited  in 
the  merchant's  account  upon  the  books  of  the  bank.  Sup- 
pose that  a  few  days  later  this  bank  for  some  reason  needs 
additional  funds,  and  in  order  to  procure  them  selects  this 
note  discounted  by  the  merchant,  endorses  it  below  the  mer- 
chant's endorsement  and  goes  to  the  Federal  reserve  bank 
of  which  it  is  a  member  and  procures  its  discount.  The  note 
has  been  rediscounted ;  it  has  now  a  triple  security  arising, 
first,  out  of  the  responsibility  of  its  maker  who  is  planning 
to  meet  it  out  of  the  funds  coming  to  him  through  the 
operations  of  his  ])nsinpss;  second,  the  value  which  the  en- 
dorsement or  guarantee  of  the  merchant  gives  to  it,  and 
finally,  the  strength  which  is  given  it  by  the  endorsement 
of  this  member  bank  which  has  discounted  it  with  the  Fed- 


94        OPERATION  OF  THE  NEW  BANK  ACT 

era!  reserve  bank.  Rediscounting  within  the  meaning  of 
the  Act  of  1913  is,  therefore,  the  sale  of  commercial  paper 
by  a  bank,  which  has  endorsed  it,  to  a  banker's  bank  whose 
business  it  is  to  buy  paper  from  banks  when  they  for  any 
good  reason  may  find  it  necessary  to  convert  a  part  of  their 
assets  into  cash.  In  the  South  it  is  considered  good  bank- 
ing for  a  bank  to  rediscount  or  borrow  from  other  banking 
institutions.  To  a  certain  extent  this  is  true  in  the  "West 
and  among  other  banks  throughout  the  country ;  but  in  the 
large  cities  and  in  the  manufacturing  districts  of  the  East, 
the  tradition  has  growTi  up  that  rediscounting  is  bad  bank- 
ing practice  and  that  no  institution  should  resort  to  it. 
This  prejudice  is  due  in  part  to  the  fact  that  the  national 
banks  must  report  rediscounts  among  their  liabilities ;  and  to 
a  large  class  of  the  banking  community  the  appearance  of 
such  an  item  in  a  bank's  statement  is  bound  to  give  rise  to 
unfavorable  comments.  In  addition,  there  is  really  no  re- 
discount market.  The  reserve  city  and  central  reserve  city 
banks,  from  which  the  funds  must  come,  are,  by  their  posi- 
tion, naturally  unwilling  to  invest  largely  in  time  paper. 
The  greater  proportion  of  their  deposits  are  subject  to 
withdrawal  upon  demand,  and  this  demand  may  come  at  any 
moment,  particularly  for  the  bankers'  deposits  which  make 
up  roughly  about  one-half  of  the  total. 

Limitations  in  the  Past  on  Rediscounting. — In  addi- 
tion, the  reserve  city  and  central  reserv^e  city  banks  as  a 
class  are  the  depositories  of  a  considerable  portion  of  the 
cash  reserves  of  the  other  banks  of  the  country.  With  this 
large  stream  of  funds  to  augment  their  operations  it  would 
appear  that  they  should  be  content  and  not  plunge  still 
further  into  debt  by  borrowing  through  rediscounts.  As 
far  as  the  matter  of  rediscounts  is  concerned  these  banks 
have  felt  that  they  should  be  lenders  and  not  borrowers. 

Even  were  the  central  reserve  city  banks  willing  to  co- 
operate by  granting  rediscounts,  their  ability  to  do  so  would 
be  very  limited.  Under  our  system  of  legislation  the  cen- 
tral reserve  city  banks,  like  all  of  the  national  banks,  are 
required  to  keep  a  minimum  reserve.    In  practice  they  keep 


REDISCOUNTS 

but  a  small  percentage  above  the  legal  minimum.  Any 
large  rediscounting,  which  would  take  cash  out  of  New 
York,  would  run  this  reserve  down  below  the  minimum, 
and  hence  would  require  the  cessation  of  rediscounting. 
Because  of  the  fact  that  the  New  York  banks  keep  practically 
all  of  their  funds  employed,  they  are  not  in  a  position  to 
meet  a  large  seasonal  demand  for  rediscounts. 

A  very  considerable  proportion  of  the  rediscounting 
which  is  done,  however,  is  handled  by  the  New  York  banks. 
The  practice,  as  it  has  developed,  is  that  a  bank  can  redis- 
count only  with  those  institutions  with  which  it  carries  a 
reserve  account,  and  that  the  amount  of  rediscounts  or 
loans  which  it  can  negotiate  depends  upon  the  balance 
which  it  carries  with  its  reserve  agent.  The  New  York 
banks  have  an  ironclad  rule  that  rediscounts  shall  not  ex- 
ceed from  four  to  five  times  the  balance  carried  by  the 
borrowing  bank.  We  therefore  have  a  situation  where  the 
rediscounts  bear  no  relation  to  the  needs  of  the  bank  which 
is  seeking  to  borrow,  or  of  the  business  community  which  it 
serves.  It  is  limited  almost  absolutely  by  the  balance  which 
is  carried  in  New  York.  The  rule  concerning  rediscounts 
works  only  one  way. 

Rediscounting  and  the  Panic  of  1907. — One  of  the 
things  which  made  the  panic  of  1907  a  national  catastrophe 
was  the  fact  that  when  the  countrs''  banks  came  to  New  York 
for  their  accustomed  loans  or  rediscounts,  they  found  that 
because  of  the  trouble,  then  confined  entirely  to  that  city, 
they  could  not  get  the  accustomed  accommodation ;  that 
they  could  not  secure  the  return  of  the  surplus  funds, 
which  they  had  on  deposit,  over  and  above  the  required  re- 
ser\'e ;  and  that,  therefore,  they  were  forced  to  follow  the  bad 
example  of  New  York  and  suspend  specie  payments  in  order 
to  protect  themselves  from  destruction.  The  new  banking 
and  currency  act  is  designed,  among  other  things,  to  elimi- 
nate this  element  of  uncertainty,  by  giving  to  the  banks  a 
dependable  source  that  will  not  drj'  up  when  the  real  need 
arises. 


9G        OPERATION  OF  THE  NEW  BANK  ACT 

Effect  of  Absence  of  Discount  Market  on  American 
Banking  Methods. — As  a  result  oi"  tlie  uucertainty  which 
has  attached  to  the  ability  of  a  bank  to  rediscount  its  com- 
mercial paper,  the  development  of  American  banking  has 
been  very  different  from  that  in  other  countries,  where  a 
large  and  dependable  rediscount  market  exists.  In  our 
large  cities,  the  collateral  loan  is  view'ed  as  the  most  desir- 
able, both  because  such  loans  can  to  a  considerable  extent 
be  made  "call  loans,"  the  repayment  of  which  can  be  de- 
manded at  any  time,  and  because  the  character  of  the  se- 
curity, especially  where  it  consists  of  listed  bonds  or  stocks, 
the  values  of  which  are  generally  known  or  easily  ascer- 
tained, makes  it  much  easier  to  shift  the  loan,  when  neces- 
sary, from  one  bank  to  another.  Both  in  theory  and  in 
fact  during  ninety-nine  out  of  every  hundred  months  a 
bank  is  at  present  safer  if  its  money  is  loaned  out  on  col- 
lateral than  if  its  funds  are  put  into  commercial  paper. 

Roughly  speaking,  the  national  banks  on  October  21, 
1913,  had  made  something  over  $6,260,000,000  of  loans  and 
discounts,  while  at  the  same  date  they  owned  bonds,  securi- 
ties, etc.,  other  than  government  bonds,  A\nth  a  book  value 
of  something  over  $1,038,000,000. 

The  method  by  which  a  bank  raises  money  through  its 
security  investments  is  well  described  by  Mr.  Andrew  J. 
Frame,  one  of  the  leading  bankers  of  the  Middle  West, 
before  the  House  Committee.  In  relating  the  experience  of 
his  bank  in  the  panic  of  1893,  Mr.  Frame  said:  "I  took 
$100,000  and  went  to  Chicago  and  sold  $50,000  of  bonds 
at  92  cents  on  the  dollar,  which  cost  us  $1.02,  so  we  lost 
$5,000  in  that  operation.  *  *  *  At  the  same  time  I 
raised  some  additional  cash.  I  found  a  broker  that  would 
lend  me  money  at  seven  per  cent  interest,  with  the  pay- 
ment of  a  small  commission  besides,  which  made  it  eight 
per  cent.  I  borrowed  $50,000,  putting  up  the  bonds  as 
collateral  security,  for  three  months.  This  cost  us  two 
per  cent  for  the  three  months.  The  bonds  we  put  up  as 
collateral  security  drew  five  per  cent  interest.  "We  paid 
eight  per  cent  for  the  $50,000.  and  therefore  lost  the  dif- 


REDISCOUNTS  97 

ference  between  five  per  cent  and  eight  per  cent  for  three 
months,  which  was  a  loss  of  three  per  cent  per  annum  on 
the  $50,000  for  three  months.  *  *  *  Three  per  cent 
per  annum  for  three  months  means  a  loss  of  only  three- 
quarters  of  one  per  cent  for  the  three  months,  so  that  it  cost 
us  $375  to  obtain  that  $50,000  over  and  above  the  rate  of 
interest  we  were  receiving  on  our  bonds. ' '  Thus  at  a  time 
when  the  rediscounting  of  commercial  paper  was  abso- 
lutely non-existent,  this  country  banker  was  able  to  raise 
the  monej'  at  a  reasonable  cost  through  the  use  of  his  securi- 
ties. 

In  spite  of  the  value  which  bankers  place  on  collateral 
loans  and  the  ownership  of  choice  securities,  the  fact  never- 
theless remains  that,  taking  the  banks  of  the  country  as  a 
whole,  and  especially  the  so-called  countr}^  banks,  com- 
mercial paper  is  given  first  place  on  the  roll  of  banking- in- 
vestment. It  is  estimated  that  $4,500,000,000  of  the  assess  of 
the  banks  are  invested  in  this  class  of  security,  far  outrank- 
ing in  amount  any  other  form  of  investment. 

Advantages  Claimed  for  Rediscounts. — The  advocates 
of  rediscounts  assert  that  the  creation  of  the  Federal  re- 
serve banks  will  revolutionize  banking  methods.  With  a 
dependable  and  ever-ready  market  for  the  rediscounting 
of  paper,  the  bankers  will  place  smaller  reliance  upon  se- 
curity investments  for  aid  in  times  of  stress,  and  will  come 
to  depend  more  upon  commercial  paper,  as  is  the  case 
abroad.  It  is  further  predicted  that  when  the  banks  have 
been  required  to  deposit  a  part  of  their  funds  with  the 
regional  banks,  the  use  of  which  can  only  be  procured 
through  rediscounting,  that  they  will  modify  their  senti- 
ments against  rediscounting,  and  that  the  practice  will 
become  almost  universal.  The  sentiment  among  bankers, 
if  we  can  judge  from  the  expressions  of  those  who  appeared 
before  the  Banking  and  Currency  Committees  of  the  House 
and  Senate,  is  almost  unanimous  that  rediscounting  under 
a  proper  system  is  good  banking  and  of  advantage  to  both 
the  banks  and  the  country. 

The  reasons  which  have  prompted  leading  bankers  of 


98         OPERATION  OF  THE  NEW  BANK  ACT 

this  country,  almost  without  exception,  to  endorse  the  pro- 
visions of  the  bill  legalizing  and  encouraging  rediscounting 
are  so  compelling  that  one  is  irresistibly  forced  to  the  con- 
clusion that  this  practice  will  prove  a  great  boon  both  to  the 
banks  and  to  the  business  community.  From  the  standpoint 
of  the  banks,  the  greatest  advantage  is  the  safety  and  se- 
curity which  it  confers,  making  it  impossible  for  a  sound 
institution  to  be  ruined  by  a  run. 

Illustration  of  Advantages  by  a  Foreign  Example. — 
Mr.  A.  Barton  Hepburn,  Chairman  of  the  Board  of  Direc- 
tors of  the  Chase  Bank  of  New  York  City,  in  making  this 
point,  gave  a  most  happy  illustration  of  the  advantages 
of  rediscount  to  the  bank  in  times  of  unexpected  pressure. 
He  said : ' '  Some  years  ago  I  called  upon  the  Credit  Lyonnais 
in  Paris,  one  of  the  great  banks  of  the  world.  The  gentlemen 
with  whom  I  was  in  conversation  passed  over  to  me  their 
last  bank  statement.  I  glanced  over  it  and  remarked,  'You 
owe  a  great  deal  of  money. ' 

"  'What  is  that  you  say?' 

"  'You  owe  a  great  deal  of  money?' 

"  'What  do  you  mean?' 

"  'Your  deposits  are  about  $350,000,000.' 

' '  '  Oh,  yes,  but  we  could  pay  them  off  easily  if  we  had  to. ' 

' '  '  Could  you  ?  How  long  would  it  take  you  to  pay  them 
off  in  case  of  necessity  ? ' 

"  'The  element  of  time  would  not  enter  into  the  matter 
at  all,  except  in  so  far  as  required  to  perform  the  physical 
labor. ' 

' '  '  Tell  me  just  how  you  would  do  it. ' 

"Almost  thinking  I  was  questioning  the  condition  of 
this  bank  he  took  the  balance  sheet  and  proceeded. 

' '  '  Well,  we  have  so  much  cash ;  we  will  deduct  that. ' 

"  'Yes.' 

' '  '  Then  we  have  so  much  due  from  banks ;  we  could  value 
against  that  and  deduct  the  same.' 

"  'Yes.' 

"  'We  have  so  much  exchange,  acceptances,  etc.,  which 
have  an  immediate  market.  We  could  realize  upon  and 
deduct  that. ' 


REDISCOUNTS  99 

"  'Yes.' 

"  'Now  we  have  reduced  our  obligations  in  this  matter 
to  something  less  than  $200,000,000,  and  we  have  very  much 
more  than  that  in  commercial  paper.' 

"  'Yes,  but  how  are  you  going  to  pay  debts  with  com- 
mercial paper?' 

"  'Take  it  to  the  Bank  of  France  and  get  currency  for 
it.' 

"  'Could  you  do  that?' 

"  'Certainly.' 

"  'Is  there  any  law  which  would  compel  the  Bank  of 
France  to  discount  your  commercial  paper  without  limit?' 

"  'Law — yes;  the  law  of  its  being;  that  is  what  the  bank 
was  created  for.' 

"I  assured  him  his  explanation  was  most  interesting, 
but  that  no  one  could  do  that  in  my  country.  I  explained 
that  in  case  of  a  strong  demand  we  first  bought  gold  abroad, 
and  if  that  was  impracticable  or  involved  too  much  time, 
we  sometimes  had  to  resort  to  clearing  house  certificates,  a 
form  of  currency  suspension,  and  frequently  perfectly  sol- 
vent banks  were  compelled  to  close  their  doors  for  want  of 
currency,  notwithstanding  that  they  had  plenty  of  good 
commercial  assets." 

This  unhappy  condition  is  fortunately  ended.  Through 
the  organization  of  the  Federal  reserve  banking  system  it 
will  be  possible  for  member  banks,  which  have  been  well 
managed  and  have  abundant  good  a.ssets,  to  discount  such 
portion  of  their  commercial  paper  as  may  be  necessarj'',  in 
order  to  secure  funds  to  extend  additional  accommodation 
to  their  customers,  or  to  meet  unusual  withdrawals  on  the 
part  of  depositors. 

Rediscounting  Will  Improve  the  Market  for  Com- 
mercial Paper. — Commercial  paper  instead  of  being  a  rela- 
tively slow  asset  will  now  become  a  prime  and  quick  asset. 
Instead  of  rplAnng  upon  chance  or  good  fortune  to  find  a 
buyer  the  bank  will  have  a  large  market  always  ready  to 
purchase  good  bills.  Mr.  Paul  N.  "Warburg,  of  the  finn  of 
Kuhn,  Loeb  &  Co.  of  New  York,  in  discussing  this  impend- 
ing change,  declared  that  commercial  paper  wiU,  because  of 


100      OPERATION  OF  THE  NEW  BANK  ACT 

this  change,  largely  take  the  place  of  the  "call  loans"  upon 
collateral  securities  as  the  secondary  reserve  of  our  banks, 
thus  making  available  for  the  business  community  a  large 
amount  of  money  which  up  to  the  present  time,  because  of 
the  inherent  defects  in  our  banking  system,  has  necessarily 
been  denied  them.  It  is  largely  upon  this  release  of  capi- 
tal, or  rather  its  diversion  into  business  channels  from  the 
present  speculative  channels,  that  the  President  and  Demo- 
cratic leaders  rely  for  the  fruition  of  their  prophecy  that 
the  new  currency  act  will  prove  a  great  boon  to  business  and 
will  increase  the  fund  of  capital  upon  which  business  men 
may  draw  in  financing  their  operations. 

Mr,  Frank  A.  Vanderlip,  President  of  the  National  City 
Bank  of  New  York  City,  declared  before  the  Senate  Commit- 
tee that ' '  undoubtedly  a  bank  Avill  feel  freer,  if  it  has  a  cen- 
tral reserve  bank  to  go  to  for  rediscounts,  than  it  does  now. 
You  have  to  depend  upon  the  good  judgment  and  conserva- 
tiveness  of  that  banker.  If  he  feels  that  he  can  rediscount 
any  time,  anything  he  has,  and  he  is  a  reckless  man,  he  will 
loan  too  much.  But  you  will  have  as  a  governor  the  power 
of  control  of  your  regional  reserve  bank  board  and  of  the 
Federal  Board.  That  is  why  I  said  that  there  is  not  an 
authority  given  to  this  Federal  Keserve  Board  Avhich  it 
ought  not  to  have.  My  objection  is  to  the  constitution  of  the 
board  and  not  to  the  authority.  If  the  bankers  in  a  locality 
are  getting  reckless,  if  they  are  loaning  more  because  they 
can  rediscount  than  is  wise  for  them  to  loan,  there  ought  to 
be  some  authority  higher  up  which  can  put  a  restraint  upon 
them." 

Advantages  from  Rediscounting  to  the  Business 
Community. — Running  parallel  with  the  feeling  of  security 
and  safety  which  rediscounting  will  confer  upon  member 
banks,  there  will  be  created  a  similar  feeling  of  assurance 
and  security  on  the  part  of  the  business  community.  The 
development  of  this  sentiment  ■v\'ill  take  time — in  fact,  it 
may  require  conspicviously  successful  handling  of  several 
succeeding  periods  of  stress  to  thoroughly  convince  the 
business  community  that  the  new  law  makes  it  possible  for 


REDISCOUNTS  101 

the  member  banks  to  take  care  of  their  borrowers  under  all 
conditions;  and  to  obviate  the  necessity  for  calling  loans 
at  a  time  when  both  business  and  banking  common  sense 
would  require  that  they  should  be  expanded,  or  at  least 
continued.  What  is  even  more  important,  the  new  law,  if 
wisely  administered,  will  eliminate  the  necessity  of  the 
suspension  of  cash  payments.  With  the  banks  able  to  re- 
discount, and  to  secure  Federal  reserve  notes  through  redis- 
counting,  there  will  no  longer  be  any  reason  for  the  hoard- 
ing of  cash  or  the  refusal  to  pay  out  money  upon  demand. 
If  foreign  experience  is  any  criterion,  the  new  law  should 
also  reduce  the  rate  at  which  commercial  loans  can  be 
placed,  because  they  will  become  more  liquid,  and  hence  more 
desirable  to  banks.  In  fact  the  present  situation,  where 
collateral  loans  can  be  placed  at  much  lower  rates  than 
commercial  paper  loans,  may  be  completely  reversed,  and 
we  may  find  the  duplication  in  this  countiy  of  European 
conditions,  where  the  commercial  borrower  secures  the 
lowest  rate  of  any  class  of  borrowers. 

Reserve  Banks  Can  Rediscount  Only  for  Member 
Banks. — It  should  be  remembered  that,  under  the  provi- 
sions of  the  Act,  the  reserve  banks  are  limited  to  the  member 
banks  in  their  purchases  or  discounts  of  commercial  paper. 
They  can  not  go  into  the  open  market  and  purchase  paper 
from  note  brokers  or  from  banks  which  are  not  stockholders 
in  the  particular  reserve  bank  which  is  seeking  an  invest- 
ment. The  underlying  motives  concerning  the  reserve  banks 
are  that  they  shall  be  bankers'  banks,  doing  business 
chiefly  with  banks,  and  having  few  direct  relations  witli  tiie 
l)usiness  public.  In  the  second  place,  the  Act  strictly  limits 
the  rediscount  privilege  to  acceptances  and  "notes,  drafts 
and  bills  of  exchange  issued  or  drawn  for  agricultural,  in- 
dustrial, or  commercial  purposes,  or  the  proceeds  of  which 
have  been  used  or  are  to  be  u.sed  for  sueh  purposes,  the 
Federal  Reserve  Board  to  have  the  right  to  determine  or 
define  the  character  of  the  paper  thus  eligible  for  discount, 
within  the  meaning  of  this  Act."  In  the  hearings  before  the 
Currency  Committees,  considerable  criticism  of  this  ])hra- 


102      OPERATION  OF  THE  NEW  BANK  ACT 

seology  was  heard,  it  being  contended  that  too  great  lati- 
tude was  given  to  the  board  in  the  definition  of  paper,  and 
that  the  power  might  be  abused.  Accordingly  a  (jualifying 
phrase  was  inserted  which  provided,  in  substance,  that  this 
clause  was  not  to  be  construed  to  prohibit  notes,  drafts  or 
bills  of  exchange  secured  by  staple  agricultural  products  or 
other  goods,  wares  or  merchandise  from  being  eligible  for 
such  discounts;  but  that  this  clause  shall  not  be  so  con- 
strued to  permit  the  rediscounting  of  * '  notes,  drafts,  or  bills 
covering  merely  investments  or  issued  or  drawn  for  the 
purpose  of  carrying  or  trading  in  stocks,  bonds  or  other 
investment  securities,  except  bonds  and  notes  of  the  Gov- 
ernment of  the  United  States." 

Mr.  Samuel  Untermyer  aptly  phrases  the  thought  under- 
lying the  definition  of  paper  eligible  for  rediscount  when 
he  states,  "Commercial  paper,  as  I  understand  it,  is  that 
which  represents  an  actual  transaction  in  the  consummated 
purchase  and  sale  of  merchandise  intended  for  resale  and 
consumption.  It  must  answer  the  test  of  being  an  obliga- 
tion that  automatically  discharges  itself  in  the  ordinary 
course  of  business. ' ' 

Why  the  Rediscount  Privilege  is  Limited  to  Com- 
mercial Paper. — Commercial  paper  is  not  necessarily  a 
safer  asset  than  many  other  kinds  of  security.  Unlike 
loans  upon  securities  it  is,  to  a  very  large  extent,  automati- 
cally liquidated  through  the  closing  of  the  business  trans- 
actions which  gave  rise  to  the  paper.  Loans  upon  secu- 
rities, on  the  other  hand,  are  really  loans  upon  a  long  time 
evidence  of  ownership  or  indebtedness  of  a  property.  The 
collateral  either  does  not  liquidate  at  all,  as  in  the  case  of 
stock;  or  if  it  does  liquidate,  as  in  the  case  of  bonds,  it  is 
usually  only  after  the  lapse  of  a  number  of  years. 

According  to  the  provisions  of  the  Act,  notes,  drafts 
and  bills  admitted  to  discount  must  have  a  maturity  at 
the  time  of  discount  of  not  more  than  ninety  days;  "pro- 
vided that  notes,  drafts,  and  bills  drawn  or  issued  for 
agricultural  purposes  or  based  on  live  stock  and  having  a 
maturity  not  exceeding  six  months  may  be  discounted  in 


REDISCOUNTS  103 

an  amount  to  be  limited  to  a  percentage  of  the  capital  of 
the  Federal  reserve  bank,  to  be  ascertained  and  fixed  by 
the  Federal  Reserve  Board."  The  foregoing  proviso  was 
inserted  at  the  instance  of  the  country  bankers,  many  of 
whom  protested  against  the  limitation  of  their  right  to 
discount  only  paper  maturing  within  ninety  days.  The 
country  bankers,  however,  were  not  unanimous  in  the 
position  that  such  limitation  worked  a  serious  hardship 
upon  them. 

Mr.  George  M.  Reynolds,  President  of  the  Continental 
and  Commercial  National  Bank  of  Chicago,  combated  the 
idea  that  the  ninety-day  limitation  inflicted  an  unusual 
hardship  upon  the  country  banker  becau.se  the  city  banker 
has  a  larger  portion  of  short-time  paper  than  the  smaller 
institutions.  He  pointed  out  that  the  law  did  not  say  that 
only  paper  running  for  a  period  of  ninety  days  or  less 
could  be  accepted ;  but  that  a  six-month  note,  for  example, 
could  be  discounted  when  the  date  of  maturity  was  not 
more  than  ninety  days  distant.  He  was  of  the  opinion  that 
the  small  banks  would  have  a  sufficient  quantity  of  the 
kind  of  paper  which  would  be  accepted  if  they  were  doing 
a  conserv\'itive  banking  business,  and  if  they  were  not 
doing  such  a  business  they  did  not  deserve  to  be  accom- 
modated. 

The  same  view  is  expressed  by  many  country  bankers, 
as  for  exarnple  by  ]\[r.  Thomas  C.  McRae,  President  of  the 
Bank  of  Prescott,  Arkansas,  who  pointed  out  that  while 
farmers'  paper  is  usually  for  from  three  to  nine  months, 
yet  inasmuch  as  this  paper  is  given  about  the  first  of 
March,  and  the  bank  does  not  need  additional  funds  until 
June  or  July,  it  follows  that  a  large  proportion  of  the 
paper  comes  within  the  three  months'  maturity  limit  before 
the  need  for  rediscounting  arises. 

Another  country'  banker,  Mr.  F.  M.  Law,  of  the  First 
National  Bank  of  Beaumont,  Texas,  stated  to  the  Senate 
Banking  and  Currency  Committee  that  generally  fifty  per 
cent  of  his  loans  are  six-months  paper,  while  twenty-five 
per  cent    run  for  less  than  this  time  and  twenty-five  per 


104       OPERATION  OF  THE  NEW  BANK  ACT 

cent  run  more  than  six  months.  He  agreed  with  Mr. 
McRae  that  the  bank  would  not  need  to  rediscount  its  six- 
months  paper  until  within  three  months  of  maturity,  be- 
cause of  the  fact  that  at  least  six  months'  time  intervened 
between  the  planting  season  when  the  paper  was  given, 
and  the  time  when  the  bank  needed  to  rediscount.  He 
declared  further  that,  from  his  experience,  he  would  con- 
clude that  under  the  worst  circumstances  at  least  one- 
half  of  the  total  loans  on  commercial  paper  would  be 
eligible  for  rediscount  at  any  time.  This  would  mean  that 
if  a  bank  were  carrying  a  fifteen  per  cent  cash  reserve, 
of  which  six  per  cent  was  in  its  own  vaults,  and  if  fifty 
per  cent  of  its  paper  were  rediscountable,  the  institution 
would  be  able  to  convert  at  least  fifty-five  per  cent  of  its 
deposits  into  cash  without  taking  into  consideration  the 
sale  of  securities  or  the  liquidation  of  collateral  loans, 
which  the  bank  might  hold. 

The  Question  of  the  Limitation  of  Ninety-day  Maturi- 
ties.— The  large  majority  of  the  country  bankers  who  pro- 
tested against  the  ninety-day  limit  agreed  substantially 
with  Mr.  Law's  conclusion  that  fifty  per  cent  of  the  com- 
mercial paper  held  by  the  country  banks  would  be  eligible 
for  rediscount  under  the  ninety-day  limit.  They  point 
out  with  great  force,  however,  that  the  situation  which  this 
would  create  contains  in  itself  elements  of  danger.  The 
maximum  expansion  in  the  loans  of  a  bank  could  not  ex- 
ceed fifty  per  cent  of  its  deposits,  for  a  larger  volume  of 
paper  for  rediscount  could  not  be  secured.  The  assumption 
that  one-half  of  the  bank's  paper  was  available  is  based, 
moreover,  upon  the  fact  that  the  bank  will  never  desire 
to  rediscount  until  the  customary  time  for  securing  money 
to  move  the  crops.  If  a  panic  should  unexpectedly  develop 
in  April  or  May  the  bank  would  be  practically  helpless; 
for  the  great  majority  of  its  paper  would  by  that  time 
have  run  only  a  month  or  two,  and  would  not  mature 
within  ninety  days.  The  system  under  these  conditions 
would  not  be  as  good  as  under  the  previous  arrangement; 
for  the  country  bank  would  have  withdrawn  its  balances 


REDISCOUNTS  105 

from  its  present  reserve  agents  in  obedience  to  the  Federal 
Reserve  Act,  and  would,  therefore,  to  a  large  degree,  have 
cut  off  its  ability  to  borrow  from  these  institutions. 

Reasons  for  Admitting  Certain  Six-month  Matu- 
rities.— It  is  because  of  this  possible  contingency  that  the 
amendment  noted  above  was  inserted  in  the  law,  which  gives 
to  the  Federal  Reserve  Board  the  power  to  extend  the 
privilege  of  rediscounting  commercial  paper  arising  out  of 
an  agricultural  loan,  or  based  on  live  stock,  having  a  ma- 
turity of  not  more  than  six  months.  It  must  be  remem- 
bered that  the  right  to  discount  six-months  paper  of  this 
character  is  not  an  absolute  one,  for  the  amount  of  such 
paper  which  a  bank  can  rediscount  is  subject  to  the  rulings 
of  the  Federal  Reserve  Board,  after  the  system  is  organized 
and  put  into  operation.  The  authority  may  be  so  narrowly 
circumscribed  as  to  contribute  but  little  to  the  successful 
handling  of  such  a  situation  as  is  outlined  above.  It  is 
probable,  however,  that  the  Federal  Reserve  Board  will 
take  a  liberal  attitude  as  regards  this  matter.  Inflation, 
if  it  occurs,  will  more  likely  appear  in  the  cities ;  and  should 
a  real  emergency  arise,  where  banks  will  be  pressed  because 
of  the  ninety-day  limit,  the  Federal  Reserve  Board  will 
doubtless  extend  every  consideration  to  them,  particularly 
if  the  report  of  the  examiners  of  the  Federal  reserve  bank, 
of  which  they  are  members,  indicates  that  they  are  sound 
and  have  been  well  managed. 


CHAPTER  X 

The  Business  op  Rediscounting 

The  Importance  of  a  Good  Reserve. — ]\Iuch  diversity 
of  opinion  has  been  expressed  by  bankers  as  to  the  extent 
to  which  rediscounting  will  be  practised.  There  is  a  gen- 
eral agreement  among  them  that  the  privilege  wiU  be 
extended  to  member  banks  only  when  they  have  a  satisfac- 
tory balance  with  the  reserve  bank.  Through  the  moral 
force  which  can  be  exerted  by  such  a  requirement,  it  is  be- 
lieved that  in  this  country  we  can  get  away  from  the  vicious 
practice  followed  by  many  bankers  of  keeping  at  all  times 
only  the  minimum  amount  of  cash  required  by  law.  Such 
a  practice  means,  in  substance,  that  the  bank  really  has  no 
reserve  in  the  true  sense  of  the  word,  for  the  minimum,  as 
specified  by  law,  is  a  "dead"  reserve.  Under  the  require- 
ments of  the  National  Bank  Act,  no  loans  or  discounts 
can  be  made  or  dividends  paid  when  the  reserve  is  below 
the  legal  limit.  A  bank,  therefore,  which  constantly  follows 
the  practice  of  keeping  as  closely  as  possible  to  the  minimum 
limit,  is  practically  unable  to  extend  additional  loans  to 
customers  in  times  of  stress.  So  far  as  taking  care  of  a 
business  community  is  concerned,  it  can  therefore  be  said 
that  the  reserve  is  "dead."  The  only  value  of  a  reserve 
that  just  meets  the  legal  limitation  is  to  promote  confidence 
on  the  part  of  the  public  in  the  solvency  of  the  bank,  and 
to  enable  it  to  meet  a  run,  or  unusual  demands  of  its  de- 
positors. However,  since  our  law  accustoms  us  to  look  upon 
a  fixed  percentage  as  necessan^  to  the  safety  of  a  bank,  when 
an  institution's  reserve  falls  below  the  legal  limit  distrust 
and  concern  are  immediately  aroused  among  its  depositors, 
and  the  severity  of  the  run  is  thereby  increased.  If  the 
reserve  banks  can  cause  that  portion  of  the  banks  of  the 
country'  which  endeavor  to  keep  as  small  a  reser^'e  as  pos- 
sible to  expand  their  reser^'^e,  keeping  a  substantial  surplus 

106 


THE  BUSINESS  OF  REDISCOUNTIXG        107 

above  the  legal  minimum,  it  will  have  accomplished  a  great 
work. 

The  Probable  Extent  of  Rediscounting. — Certain 
prominent  business  men  and  bankers  stated  to  the  Senate 
Committee  on  Banking  and  Currency  that  in  their  opinion 
the  demand  for  rediscounting  would  be  only  occasional 
and  would  be  confined,  generally  speaking,  almost  entirely 
to  the  few  weeks  of  the  crop-moving  period.  During  the 
balance  of  the  year  the  funds  lying  in  the  vaults  of  the 
reserve  banks  would  be  practically  idle.  Expenses  of  opera- 
tion would  continue  and,  under  these  circumstances,  it 
would  be  impossible  for  them  to  earn  a  fair  profit.  The 
temptation  of  their  boards  of  directors  to  put  the  money 
to  work  would  be  almost  irresistible,  and  this  might  lead 
to  serious  trouble  because  it  would  encourage  the  regional 
banks  to  make  loans  upon  a  basis  which  would  be  disastrous 
to  business  conditions  generally,  causing  inflation  or  over- 
extension of  bank  credit. 

This  group  of  men  argued  strongly  that,  if  their  con- 
clusions were  correct,  it  would  be  better  to  utilize  the 
present  clearing  house  associations  in  the  large  cities,  which 
have  had  a  definite  work  to  perform,  and  to  give  to  them 
the  power  of  rediscounting  and  of  note  issue.  "Without 
stopping  to  examine  the  correctness  of  this  contention,  which 
can  not  be  determined  until  we  have  investigated  the  ques- 
tion of  note  issue  and  the  other  work  which  the  reserve 
banks  will  do,  it  should  be  observed  that  the  great  majority 
of  bankers  who  appeared  before  the  Congressional  com- 
mittees did  not  share  this  gloomy  view. 

A  large  number  of  them  expressed  the  opinion  that  re- 
discounts should  and  will  be  very  moderate  at  first.  iMr. 
Sol  Wexler,  one  of  the  leading  bankers  of  the  South,  stated 
that  in  his  judgment  rediscounts  were  needed  "only  in 
time  of  stress."  ]\Iany  bankers  did  not  go  as  far  as  Mr. 
Wexler,  but  the  consensus  of  opinion  was  that,  in  the  begin- 
ning at  least,  they  should  be  very  moderate. 

Arguments  for  and  against  the  Practice. — It  is  almost 
impossible  to  form  any  accurate  conclusion  as  to  the  extent 


108       OPERATION  OF  THE  NEW  BANK  ACT 

to  which  rediscountiiig  will  be  doue.  We  have  next  to  ex- 
amine the  statistics  concerning  the  amount  of  rediscount- 
ing  now  done  by  the  national  banks  in  the  various  sections 
of  the  country.  We  find,  in  brief,  that  on  October  21, 
1913,  the  national  banks  had  rediscounted  with  other 
national  banks  $16,516,347.34  of  notes  and  bills,  and  that 
they  had  borrowed  on  their  own  notes  $83,943,695.90.  This 
borrowing  has  been  confined  in  the  past  almost  entirely  to 
the  country  banks,  and  has  been  limited  because  of  the 
lack  of  any  large  source  from  which  such  loans  could  be 
procured.  The  bankers  are  divided  as  to  the  view  which 
the  reserve  and  central  reserve  city  banks  will  have  on  the 
advisability  of  beginning  the  practice.  Many  contend  that 
because  of  the  removal  of  the  reasons  which  have  given 
rise  to  the  objections  and  because  of  the  fact  that,  as  we 
shall  see  later  on,  a  veiy  severe  strain  will  be  put  upon  the 
central  reserve  cities  to  repay  the  balances  carried  with 
them  by  their  country  correspondents,  these  banks  will  be 
forced  to  adopt  it.  On  the  other  hand,  bankers  equally  as 
eminent  assert  that  it  w'ill  take  years  to  develop  a  practice 
of  rediscounting  by  central  reserve  and  reserve  city  banks. 
The  latter  group  are  of  the  opinion  that  the  funds  which 
must  be  provided  by  the  readjustment  of  the  reserve  of 
the  member  banks  wall  be  procured  by  the  New  York,  Chicago 
and  other  central  reserve  and  reserve  city  banks  through  re- 
calling the  collateral  loans  as  rapidly  as  can  safely  be  done, 
and  through  the  collection  of  the  commercial  paper  which 
these  banks  have  purchased  for  investment.  If  this  should 
prove  to  be  the  plan  followed,  it  will  mean  that  the  large  bor- 
rowers, whose  paper  has  been  sold  by  note  brokers  or  has  been 
discounted  directly  by  the  large  banks  in  big  cities,  will 
suddenly  find  their  accustomed  line  of  credit  cut  off,  and 
will  be  forced  to  seek  new  channels  for  loans.  Such  a  revo- 
lution in  lending  methods  would  lead  to  considerable  uncer- 
tainty and  some  trouble  for  the  business  interests.  It  is  to 
be  hoped,  however,  that  no  such  situation  will  develop.  If 
the  New  York  banks  should  curtail  to  a  large  degree  their 
purchases  of  commercial  paper,  it  would  seem  to  follow 


THE  BUSINESS  OF  REDISCOUNTING         109 

that  the  rediscounts  of  other  banks  would  thereby  be  sympa- 
thetically increased,  for  these  institutions  will  be  induced 
to  buy  the  choice  paper  formerly  purchased  by  the  New 
York  banks,  procuriuGr  the  funds  thnnifrh  rediscounts. 

Rediscounting  Will  Grow  in  Favor. — However,  we 
must  remember  that  bankers  are  proverbially  cautious  men, 
and  it  is  likely  that  the  practice  of  rediscountinfj  will  be 
resorted  to  slowly  and  with  great  caution.  Until  more  is 
known  concerning  the  exact  geographical  limits  and  the 
number  of  the  resen^e  banks,  it  is  impossible  to  tell  to  what 
extent  each  particular  bank  will  find  a  demand  for  funds 
through  rediscounts  by  their  members.  Should  the  prac- 
tice of  rediscounting  become  popular,  it  is  inevitable  that 
it  will  shift  the  secondary  reserve  of  the  banks  from  call 
loans  to  commercial  paper.  There  is  no  market  at  present 
for  call  loans  in  time  of  stress.  But  if  the  reserve  banks 
should  prove  to  be  strong,  in  the  sense  that  they  have  large 
resources  and  are  able  to  take  care  of  the  needs  of  their 
members,  a  feeling  of  security  will  inevitably  develop.  It 
was,  therefore,  the  consensus  of  opinion  of  the  great  ma- 
jority of  the  bankers  who  expressed  themselves  before  the 
Congressional  committees  that  as  the  years  go  on  the  desir- 
ability of  commercial  paper  as  a  banking  asset  will  steadily 
increase,  while  at  the  same  time  the  rating  of  the  collateral 
or  call  loan  will  correspondingly  diminish  in  favor. 

Objections  of  Borrowers  Considered. — Considerable 
attention  was  given  l^y  bankers,  in  their  analysis  of  the 
bill  while  it  was  before  Congress,  to  the  practical  working 
out  of  the  business  of  rediscounting.  ]Many  bankei*s  were 
strongly  of  the  opinion  that  business  men  would  not  take 
kindly  to  having  their  notes  rediscounted  with  a  Federal 
reserve  bank  with  which  they  had  no  business  relations. 
and  which  was,  perhaps,  situated  at  a  considerable  dis- 
tance. This  objection  was  made  very  emphatically  con- 
cerning the  farmers,  who,  it  was  stated,  would  look  with 
great  disfavor  upon  the  sale  of  their  notes  to  another  bank. 
Country  bankers  gave  this  objection  as  one  of  the  reasons 


110      OPERATION  OF  THE  NEW  BANK  ACT 

why  they  preferred  to  borrow  upon  the  bank's  note  rather 
than  rediscount. 

Presuming  that  when  a  note  which  a  Federal  reserve 
bank  has  rediscounted  for  a  customer  of  one  of  its  member 
banks  comes  due,  the  resei've  bank  will  use  the  member 
bank  in  question  as  a  collection  agency  in  much  the  same 
manner  as  banks  now  collect  notes  for  each  other,  the  cus- 
tomary procedure  will  be,  in  substance,  as  follows :  The 
note  wiU  either  be  sent  by  mail  to  the  member  bank  several 
days  before  it  is  due,  the  proceeds  of  the  note  being  charged, 
at  the  time  the  note  is  sent,  to  the  account  of  the  member 
bank  to  which  it  is  transmitted,  or  the  note  sent  for  collec- 
tion. If  the  customer  should  desire  to  take  up  his  note 
prior  to  the  time  of  its  maturity,  he  might  raise  an  objection 
upon  finding  that  it  was  no  longer  in  the  hands  of  his  bank, 
it  having  been  rediscounted  with  a  reserve  bank.  In  that 
event,  several  days  might  elapse  before  the  member  bank 
could  secure  its  return. 

Rediscounting  to  Secure  Notes. — "When  the  reserve 
bank  has  used  the  paper  rediscounted  by  the  member  in- 
stitution as  collateral  for  the  issue  of  Federal  reserve  notes, 
additional  complications  will  develop.  The  law  specifies 
that  in  such  instances  the  commercial  paper  rediscounted 
and  used  as  the  basis  of  security  for  the  Federal  reserve 
notes  shall  be  turned  over  to  the  Federal  reserve  agent  in 
charge  of  that  particular  reserve  bank,  and  held  by  him 
separate  and  apart  from  the  bank 's  assets.  The  Act,  how- 
ever, further  pro\ides  that  "Any  Federal  reserve  bank  may 
at  its  discretion  withdraw  collateral  deposited  'U'ith  the  local 
Federal  reserve  agent  for  the  protection  of  its  Federal  re- 
serve notes  deposited  with  it,  and  shall  at  the  same  time  sub- 
stitute therefor  other  like  collateral  of  equal  amount  with 
the  approval  of  the  Federal  reserve  agent  under  regulations 
to  be  prescribed  by  the  Federal  Keserve  Board."  Under 
this  provision  it  will  be  possible  for  a  member  bank  to 
secure  the  return  of  the  note  of  a  customer  desiring  to 
take  it  up  before  maturity  or  to  arrange  that  the  note  shall 
be  returned  to  it  and  be  in  its  possession  at  the  time  when 


THE  BUSINESS  OF  REDISCOUNTING         111 

it  matures.  In  all  likelihood  the  business  man  vviU  have  no 
difficulty  because  of  the  fact  that  his  paper  will  be  redis- 
counted.  In  case  he  does  not  desire  to  pay  the  note  before 
it  matures,  he  will  have  no  knowledge  of  the  fact  that  his 
note  has  been  rediscounted,  except  that  the  note,  when  paid 
and  returned  to  him,  will  bear  the  endorsement  which  was 
put  upon  it  by  the  member  bank  as  a  means  of  procuring 
its  rediscount  by  the  Federal  reserve  bank. 

Difficulties  with  Renewed  Paper. — Another  complica- 
tion which  may  arise  is  in  the  handling  of  commercial  paper 
which  is  renewed  in  whole  or  in  part.  Country  bankers 
have  pointed  out  that  in  many  cases  farmers  can  not 
pay  their  notes  upon  the  exact  day  when  they  fall  due. 
There  are  many  things  which  may  delay  the  receipt  of  an- 
ticipated funds,  such  as  wet  weather,  delayed  harvesting 
and  marketing  of  grain,  bad  roads,  etc.,  and  often  while  a 
loan  is  perfectly  good,  it  may  not  be  paid  until  some  days 
after  maturity.  It  would  be  difficult,  if  not  impossible,  to 
"jog  the  farmer  out  of  his  regular  rut,"  and  he  would  re- 
sent vigorously  any  attempt  on  the  part  of  the  bank  to 
compel  him  to  pay  promptly  upon  the  day  when  his  note 
falls  due.  If  his  notes  were  held  by  the  reserve  bank,  it 
would  be  necessary  to  charge  them  back  against  the  member 
bank  when  due,  returning  them  with  the  daily  collections. 
It  would  be  very  difficult  for  the  Federal  reserve  bank, 
under  such  circumstances,  to  form  an  intelligent  judgment 
of  the  extent  to  which  commercial  paper  was  being  taken 
up  at  maturity.  Some  idea  of  the  conditions  surrounding 
farmers'  loans  can  be  secured  from  the  computation  made 
by  Taylor  Vinson,  E.sq.,  a  lawyer  of  Huntingdon,  West 
Virginia,  who  found  that  "Generally  speaking,  about  forty 
per  cent  of  the  loans  made  by  banks  in  the  community  were 
paid  promptly  upon  maturity,  the  balance  being  renewed." 

If  we  can  accept  Mr.  Vinson's  conclusions  as  typical  of 
conditions  throughout  the  agricultural  districts,  it  would 
appear  that  the  greater  amount  of  the  commercial  paper 
rediscounted  with  a  Federal  reserve  bank  would  not  be  paid 
upon  maturity.     While  in  all  probability  a  renewal  note 


IIZ      OPERATION  OF  THE  NEW  BANK  ACT 

would  not  be  sent  forward  immediately  to  the  reserve  bank 
(because  of  the  fact  that  the  renewal  might  run  for  a  period 
exceeding  ninety  days)  yet  the  volume  of  commercial  paper 
would  not  be  contracted,  for  the  renewal  note  would  be 
held  in  the  portfolios  of  the  bank.  Some  of  the  witnesses 
before  the  Senate  and  House  committees  contended  that 
the  assets  which  would  stand  behind  the  Federal  reserve 
notes  were  not  as  liquid  as  would  appear  upon  the  surface. 
The  real  reliance  for  a  contraction  in  the  amount  of  Fed- 
eral reserve  notes  which  may  be  issued  from  time  to  time, 
is  placed  in  the  fact  that  when  the  demand  for  additional 
funds  ceases,  the  notes  will  be  retired  through  the  taking  up 
of  the  commercial  paper  which  has  been  rediscounted  with 
the  Federal  reserve  bank.  Should  it  transpire  that  a  large 
proportion  of  commercial  paper  rediscounted  is  renewed 
again  and  again,  then  the  expected  contraction  of  the  cir- 
culating medium  will  not  occur. 

Influences  Forcing  Contraction. — Mr.  Sol  Wexler 
voiced  the  sentiment  of  the  majority  of  bankers  who  have 
discussed  this  feature  when  he  said  that  there  w^as  no  real 
danger  because  the  Federal  discounting  bank  would  get  its 
money  in  any  event.  The  member  bank  discounting  it 
"having  endorsed  the  paper,  even  though  it  had  to  renew 
the  note  to  John  Smith  w^hieh  had  matured  in  ninety  days 
and  was  not  paid,  would  go  over  to  the  central  or  regional 
bank  and  take  up  that  note.  In  a  week  afterwards  it  might 
come  and  bring  John  Smith's  new  ninety-day  note  and 
rediscount  it,  but  in  the  meantime  the  government,  if  j'ou 
have  a  government  bank,  or  the  central  reserve  bank  or  the 
regional  bank  would  have  its  money,  and  there  would  be 
nothing  to  prevent  it  from  getting  its  money."  He  de- 
clared that  the  renewal  of  a  note  was  a  voluntary  matter 
on  the  part  of  the  bank,  and  that  his  banking  experience  had 
shown  that  if  the  bank  was  firm  in  its  demand  that  the 
note  be  paid,  the  merchant  or  business  man  would  do  so, 
even  though  "he  may  have  to  make  sacrifices.  He  may 
have  to  sell  commodities  or  securities  or  whatever  he  may 
have,  but  he  meets  it,  because  his  whole  future  and  com- 


THE  BUSINESS  OF  REDISCOUNTING        113 

mercial  standing  depend  upon  meeting  it.  lie  does  not 
know  who  holds  his  note  or  to  whom  to  go  to  get  extension." 

Mr.  Charles  A.  Conant,  of  New  York  City,  agreeing  with 
Mr,  Wexler's  conclusions,  added  "that  even  though  you 
have  a  substratum  of  paper  wliich  is  not  readily  convertible 
to  meet  a  demand  for  a  great  many  outstanding  notes,  you 
have  a  margin  which  is  convertible.  If  you  choose  you 
can  say  to  your  better  class  of  clients  who  apply  for  renewal, 
'I  will  renew  for  seventy-five  per  cent  of  your  note,'  the 
result  is  that  the  bank  is  able  to  convert  at  least  part  of  its 
assets  into  cash,  to  meet  the  pressure  of  withdrawals  of 
deposits,  if  they  occur,  and  to  swell  metallic  resources  if 
it  has  demands  for  loans."  He  said  that  he  thought  that 
American  commercial  paper  ' '  ought  to  be  more  liquid  than 
it  is,  but  there  is  no  serious  risk  if  we  have  a  margin  supply 
which  is  liquid,  and  if  we  have  a  method  by  which  the 
banks  can  rediscount  with  the  marginal  supply  as  a  means 
of  accommodating  their  depositors." 

These  conclusions  are  fortified  by  the  experience  of  the 
banks  in  the  panic  of  1907.  In  those  distressing  times 
every  merchant's  calculations  were  upset  by  the  fact  that 
his  anticipated  collections  did  not  materialize.  Neverthe- 
less it  was  true  that  nearly  every  dollar  of  the  short  time 
commercial  paper  Avhich  had  been  put  out  through  note 
brokers,  and  which  aggregated  an  enormous  total,  was 
paid  promptly. 

The  Responsibility  is  on  the  Bankers. — One  of  the  ar- 
guments which  can  be  advanced  in  favor  of  bankers'  con- 
trol of  the  Federal  reserve  banks  arises  in  connection  with 
the  point  that  paper  will  be  indefinitely  renewed  and  not 
retired  when  business  prudence  demands  that  it  should  be 
paid.  The  majority  of  the  directors  of  the  Federal  reserve 
banks  will  ])e  elected  by  the  member  banks,  and  will  pre- 
sumably reflect  the  general  sentiment  among  the  member 
banks.  When  the  consensus  of  opinion  among  the  member 
hanks  is  clear  that  contraction  in  commercial  loans  should 
\  occur,  the  directors  whom  they  have  elected  can  force  the 
contraction.  They  can  require  the  menibor  banks  to  reduce 
8 


114       OPERATION  OF  THE  NEW  BANK  ACT 

the  amount  of  their  discounts  by  positive  limitations,  or 
they  can  accomplish  the  same  purpose  through  a  change  in 
the  rate  of  interest  on  rediscounts,  in  a  manner  which  will 
be  developed  in  a  later  chapter.  If  there  is  an  expansion 
of  credit,  it  must  occur  through  the  lack  of  judgment  on 
the  part  of  most  of  the  bankers  of  the  country.  Moreover 
we  must  recollect  that  the  Federal  Reserve  Board  can  dis- 
ciphne  any  reserve  bank  which  has  taken  too  liberal  a 
policy  in  rediscounting. 

Branches  Will  Aid  in  Rediscounting. — A  very  com- 
pelling argument  in  support  of  the  regional  system  is  the 
great  facility  which  regional  banks  provide  for  the  redis- 
count of  paper.  The  Aldrich  plan,  it  will  be  remembered, 
created  a  central  institution  with  fifteen  branches.  It 
practically  recognized  the  necessity  of  the  regional  banks 
for  rediscount  purposes  by  providing  regional  boards  of 
directors  which  should  manage  the  fifteen  branches,  and 
which  should  pass  upon  the  rediscounts  offered  by  the  con- 
stituent banks.  In  so  far  as  the  work  of  rediscounting  is 
concerned,  there  were  no  advantages  secured  by  the  Aldrich 
plan  which  will  not  be  found  in  the  Federal  Reserve  Act. 
We  will  omit  at  this  point  any  discussion  covering  the 
extent  of  the  control  which  will  be  exercised  by  the  Federal 
Reserve  Board  as  contrasted  by  that  which  could  be  exer- 
cised by  the  Central  Reserve  Association  under  the  Aldrich 
plan.  Both  plans  recognize  that  it  would  be  impossible  to 
work  out  a  satisfactory  system  of  rediscount  through  a 
central  bank  with  only  one  place  of  business,  for  it  would 
be  too  far  distant  from  the  member  banks.  The  time  re- 
quired to  transmit  commercial  paper  between  the  member 
banks  and  the  central  institution  would  be  almost  fatal  to 
the  successful  operation  of  the  plan. 


CHAPTER  XI 

Foreign  Acceptances 

Why  the  Act  Permits  Acceptances. — Section  13  of  the 
Federal  Reserve  Act,  defining  the  powers  of  the  reserve 
banks,  provides,  in  part,  that  "Any  member  bank  may 
accept  drafts  or  bills  of  exchange  drawn  upon  it  and  grow- 
ing out  of  transactions  involving  the  importation  or  expor- 
tation of  goods  having  not  more  than  six  months'  sight  to 
run ;  but  no  bank  shall  accept  such  bills  to  an  amount  equal 
at  any  one  time  in  the  aggregate  to  more  than  one-half  its 
paid-up  capital  stock  and  surplus." 

The  purpose  of  this  section  is  to  create  an  acceptance 
market  in  this  country  similar  to  that  which  exists  in  Europe 
and  which  has  been  of  the  greatest  value  in  assisting  Euro- 
pean merchants  to  develop  their  foreign  commerce. 

At  the  present  time  almost  all  of  the  business  of  Central 
America  and  South  America  with  foreign  nations  is  done 
upon  acceptances.  Our  merchants  are  placed  under  a 
severe  financial  handicap  in  competition  with  foreigners, 
because  our  bankers  can  not  extend  to  them  terms  as  favor- 
able as  those  which  their  rivals  procure.  This  section  was 
inserted  in  the  Act  as  a  remedy. 

Foreign  Practice. — Bank  acceptances  have  heretofore 
been  illegal  under  the  judicial  interpretation  of  the  National 
and  State  Banking  Acts.  A  bank  acceptance  is  the  same 
as  the  acceptance  of  a  draft  by  a  merchant  in  domestic 
exchange  operations.  The  procedure  abroad  is,  in  brief,  as 
follows :  A  merchant  who  is  not  well  known,  or  whose  paper 
is  not  salable  on  his  own  credit,  goes  to  what  is  known  as  an 
"acceptance  house."  Although  some  of  the  banks  act  as 
acceptors,  most  of  the  business  is  done  by  institutions  that 
are  not  primarily  banks  as  the  word  is  used  in  this  country. 
They  were  originally  great  commercial  houses  which  added 
banking  functions  to  their  business  because  of  the  profits 

115 


116       OPERATION  OF  THE  NEW  BANK  ACT 

which  they  could  secure  through  their  prominence  as  mer- 
chants. The  foreign  acceptance  houses  developed  from 
firms  which  compare  roughly  with  such  firms  in  this  country 
as  John  Wanamaker  or  IMarshall  Field  &  Company,  which  do 
an  enormous  importing  business,  and  which,  through  a  long 
period  of  time,  have  built  up  for  themselves  an  international 
reputation  and  a  very  high  credit  rating  abroad.  There  are 
many  houses  of  this  character  in  London,  Berlin  and  the 
other  European  financial  and  commercial  centers.  Grad- 
ually such  firms  were  importuned  to  lend  their  credit  to 
less  widely  known  merchants  who  desired  to  finance  the 
importation  of  goods.  As  the  opportunities  for  profits 
through  so  doing  developed,  these  houses  became  almost,  if 
not  actually,  banking  institutions.  They  have  confined  their 
business,  however,  almost  entirely  to  the  accepting  of  drafts. 
They  are  not  banks  of  deposit.  They  do  not  issue  notes,  they 
do  not  discount  paper  and  they  meet  demands,  not  with  cash, 
but  with  checks  on  banks. 

Borrowing  on  an  Acceptance. — A  merchant  whose 
credit  is  not  known  in  the  country  in  which  he  desires  to 
make  purchases  will  go  to  an  acceptance  house  and  will 
arrange  Avith  it  to  give  him  a  letter  of  credit  for  say  £10,000. 
The  acceptance  house,  after  carefully  investigating  the  man 
and  satisfying  itself  as  to  his  responsibility,  will,  for  a  com- 
mission, grant  him  the  privilege  of  having  bills  of  ex- 
change drawn  upon  them,  which  they  accept  when  pre- 
sented. They  will  write  across  the  face  of  the  bill  the  word 
"accepted"  and  affix  thereto  their  firm  signature,  just  as  a 
merchant  in  this  country  does  with  a  domestic  time  draft. 

This  accepted  draft  thereby  becomes  two  or  three  name 
paper,  as  the  case  may  be,  and  when  the  accepting  house  is 
of  the  first  rank,  has  the  highest  rating  in  European  financial 
circles.  The  drafts  are  purchased  by  recognized  discount 
houses.  Great  corporations  like  the  London  City  and  Mid- 
land Bank  and  the  Discount  Bank  of  London  make  a  prac- 
tice of  buying  accepted  bills  and  commercial  paper  in  the 
open  market. 


FOREIGN  ACCEPTANCES  117 

The  Practice  an  Old  One. — It  must  be  borne  in  mind 

that  this  very  admirable  system  of  financing  foreign  trade 
is  the  outgrowth  of  centuries,  and  is  the  direct  result  of  the 
development  of  the  acceptance  houses  and  of  an  immense 
foreign  trade  which  gives  them  a  tremendous  field  for  their 
business.  It  has  proved  impossible  to  duplicate  the  system 
in  this  country,  because  we  have  no  great  galaxy  of  import- 
ing houses  of  the  character  existing  abroad.  But  even  if  we 
can  not  duplicate  the  foreign  system,  we  may  secure  the 
same  benefits  if  we  adapt  our  banking  institutions  in  such  a 
manner  as  will  enable  them  to  create  paper  of  equal  safety 
and  desirability  as  that  which  exists  abroad.  This  the 
Federal  Reserve  Act  attempts  to  do. 

The  Act,  it  will  be  observed,  limits  the  privilege  of 
acceptance  to  bills  arising  in  the  foreign  trade.  At  one  stage 
of  the  discussion  it  was  proposed  to  grant  the  privilege  of 
accepting  domestic  bills  or  drafts;  but  so  great  was  the 
opposition  from  the  bankers,  and  so  cogent  were  their  argu- 
ments against  this  feature,  that  it  was  dropped  out  of  the 
law. 

The  acceptance  of  a  bill  is,  in  reality,  a  loan  on  the  bank 's 
endorsement  for  one  of  its  customers,  the  bank  guaranteeing 
that  the  draft  will  be  paid  by  the  customer  when  due,  which 
may  be  several  months  from  the  date  of  the  acceptance.  The 
inauguration  of  such  a  practice  marks  a  radical  departure 
in  American  banking  methods. 

Different  Ways  of  Using  Acceptances. — Acceptances 
are  given  by  European  banks  and  bankers  in  connection 
with  two  kinds  of  drafts — the  documentary  bill  and  the 
commercial  credit  bill — to  finance  importations  and  expor- 
tation of  merchandise  and  commodities.  Of  these  the  docu- 
mentary bill  is  probably  the  most  important.  If  an  Ameri- 
can jncix'liant  desires  to  purchase  coft'ee  in  Brazil  he  will 
probably  finance  it  by  arranging  for  a  documentary  credit 
in  London,  by  which  the  London  banker  will  agree  to 
accept  a  three-months  bill  drawn  on  the  London  bank  by 
the  Bi-azilian  shipper.     Attached   thei-eto  will   be  the  bill 


118      OPERATION  OF  THE  NEW  BANK  ACT 

of  lading,  insurance  policies,  etc.,  covering  the  shipment  of 
coffee.  The  face  of  the  bill  will  call  for  the  amount  of 
the  purchase  price  of  the  coffee,  plus  such  charges  as  the 
shipper  might  incur  in  behalf  of  his  customer.  The  Bra- 
zilian shipper,  in  all  probability,  will  sell  this  bill  to  his  local 
bank,  which  will  buy  it  without  hesitation  because  it  is 
drawn  on  a  first-class  European  banking  house  whose  credit, 
as  a  result  of  years  of  business,  has  been  thoroughly  estab- 
lished. The  bill  or  draft  is  accompanied  by  an  order  bill 
of  lading.  If  the  Brazilian  bank  doubts  that  the  shipper  has 
the  right  to  draw  upon  the  European  banking  house,  it  will 
demand  that  the  exporter  produce  the  letter  of  credit  against 
which  the  bill  is  drawn,  which  is,  in  substance,  an  offi- 
cial authorization  issued  by  an  American  bank,  entitling 
the  purchaser  of  the  coffee  to  draw  upon  the  London  bank 
up  to  a  certain  stipulated  sum,  the  London  bank  to  charge 
this  amount  to  the  account  of  the  American  bank.  The  bill 
purchased  by  the  Brazilian  bank  is  one  of  its  choicest  in- 
vestments. After  acceptance  by  the  London  bank  upon  w^hich 
it  is  drawn,  it  may  be  sold  in  England  or  on  the  Continent. 
Because  of  the  extensive  demand  for  such  bills,  it  is  certain 
to  be  discounted  without  hesitation.  Often  such  bills  are 
discounted  with  one  of  the  Brazilian  bank 's  correspondents, 
thereby  enabling  it  to  secure  indirectly  a  credit  which  is 
equivalent  to  cash  upon  the  books  of  its  foreign  corre- 
spondent. If  the  Brazilian  bank  prefers  to  do  so,  it  can 
definitely  determine,  in  advance,  the  profit  which  it  will 
make  on  the  transaction  by  cabling  to  Europe  and  ascertain- 
ing the  discount  w^hieh  will  be  charged  for  converting  the 
bill  into  cash  when  it  arrives  in  Europe. 

Details  of  Financing  Imports  with  an  Acceptance. — 
After  the  bill  has  been  purchased  by  the  Brazilian  bank,  it 
is  immediately  mailed  to  Europe  and  in  due  course  is  pre- 
sented to  the  bank  upon  which  it  is  drawn,  which  accepts  it, 
and  thereby  obligates  itself  to  pay  the  bill  when  due.  The 
accompanying  documents  are  left  with  the  accepting  bank, 
and,  in  the  case  which  we  have  supposed,  would  probably 
be  sent  by  it  to  the  American  banker  bv  whom  the  letter  was 


FOREIGN  ACCEPTANCES  119 

origiually  issued.  This  bank,  upon  the  arrival  of  the  coffee, 
would  deliver  the  bill  of  lading  to  the  American  importer 
only  upon  such  terms  as  may  be  agreed  upon.  The  Ameri- 
can bank  must  furnish  funds  to  the  London  bank  before 
the  accepted  draft  falls  due,  and  prior  to  that  date  must 
secure  this  sum,  plus  a  commission,  from  the  importer. 
The  banks  have  been  protected  thus  far  by  the  bill  of  lading 
and  this,  or  a  warehouse  receipt  if  the  goods  are  already 
at  hand,  will  be  surrendered  without  formality  if  the  impor- 
ter's  credit  is  unusually  good,  or  only  upon  the  payment  of 
the  cash  if  his  rating  is  very  poor.  The  most  common  prac- 
tice, however,  is  to  require  him  to  sign  a  trust  receipt,  by 
whose  tenns  he  binds  himself  to  hold  the  goods  in  trust  and 
deliver  to  the  bank  the  proceeds  of  his  sales  as  they  are 
received. 

This  method  is  the  one  employed  to  finance  a  very  large 
proportion  of  our  importations  of  merchandise,  especially 
of  raw  materials.  The  American  banker  arranges  for  the 
acceptances  at  a  foreign  bank,  because  he  finds  that  shippers 
and  wholesale  houses  in  China,  South  America  or  Europe 
will  not,  as  a  rule,  readily  take  the  obligation  of  an  Ameri- 
can private  bank.  The  American  bill  has  not  as  ready  a 
market  as  the  London  bill,  because  the  American  banks  are 
not  so  widely  and  so  favorably  known  as  'the  large  London 
banks  and  accepting  houses,  and  also  because  the  amount 
and  direction  of  our  foreign  trade  do  not  create  a  demand 
for  American  exchange.  Countries  that  do  not  have  large 
imports  from  the  United  States  have  little  need  for  accounts 
with  banks  here. 

Commercial  Credit  Bills. — Following  the  documentary 
bill  in  importance  is  the  two  or  three  months'  bill,  drawn  on 
a  bank  or  banker,  constituting  commercial  credit  granted 
by  the  bank  to  its  customer.  The  arrangement  underlying 
such  a  bill  is  comparatively  simple.  The  European  banker 
allows  his  customer,  who  m<ay  be  importing  goods  from 
America,  to  have  drafts  dra^vn  on  the  European  bank  at 
two  or  three  months'  sight,  the  customer  agreeing  that 
he  will  place  funds  in  the  bank  several  days  before  the  bill 


120      OPERATION  OF  THE  NEW  BANK  ACT 

falls  due.  If  the  agreement  is  faithfully  carried  out  the 
bank  will  not  have  to  put  up  any  cash,  merely  placing  its 
endorsement  on  the  paper  of  its  customer.  In  some  cases 
an  arrangement  is  made  with  the  bank  by  which  the  bill 
may  be  renewed  at  maturity.  The  majority  of  these  com- 
mercial credit  bills  are  drawn  without  collateral ;  where 
collateral  is  given,  it  frequently  consists  of  the  pledge  of 
the  merchant's  bills  receivable,  or  of  collateral  securities. 

Commercial  credit  bills,  however,  in  point  of  importance 
are  insignificant  as  compared  with  the  volume  of  documen- 
tary bills  handled.  As  a  general  rule,  English  bankers 
avoid  accepting  long  bills  for  local  customers  who  are  accom- 
modated by  cash  advances.  The  greater  proportion  of 
acceptances  are  for  out-of-town  customers.  While  there 
is  no  absolute  rule,  yet  it  may  be  said  that  the  joint  stock 
banks  of  England  accept  only  against  collateral ;  while  many 
important  private  banking  firms  and  banks,  which  often 
make  accepting  their  exclusive  business,  grant  uncovered 
credits  to  a  very  large  extent.  This  sharp  classification  does 
not  exist  in  France  or  Germany,  where  the  sort  of  credit 
granted  is  controlled  apparently  only  by  the  facts  in  each 
particular  case,  and  not  in  accordance  with  a  general  rule. 

American  Practice. — As  contrasted  with  the  European 
methods  of  financing  foreign  trade,  our  methods  are  very 
defective.  It  is  difficult,  if  not  impossible,  to  give  any  ade- 
quate brief  description  of  the  methods  of  financing  Ameri- 
can trade,  for  the  reason  that  the  exact  arrangement  differs 
widely  with  various  classes  of  business.  In  the  export  trade, 
for  example,  different  commodities  are  handled  in  accord- 
ance with  special  customs  which  have  grown  up  around 
them,  partly  as  the  result  of  trade  conditions  and  partly 
because  of  the  nature  of  the  commodity.  In  the  exportation 
of  grain  the  seller  will  draw  at  sixty  days'  sight  upon  the 
foreign  buyer,  instead  of  under  a  bank  credit.  Such  drafts, 
with  the  bills  of  lading  and  such  other  documents  as  are 
necessary  attached,  are  purchased  by  American  bankers 
and  forwarded  by  them  to  their  European  correspondents. 
In  all  probability  the  draft  is  originally  purchased  by  an 


FOREIGN  ACCEPTANCES  121 

interior  bank,  which  forwards  it  to  some  New  York  institu- 
tion to  which  the  draft  is,  in  substance,  re-sold.  The  Ameri- 
can banker,  generally  in  New  York,  is  obliged  to  advance 
the  money  on  such  paper,  unless  he  draws  his  own  time  bills 
against  them  until  such  time  as  they  are  rebated.  With 
grain  bills,  the  average  time  of  rebating  is  around  fifty-six 
days,  which  places  the  American  bank  in  possession  of  de- 
mand foreign  exchange  against  which  it  can  draw  in  order 
to  reimburse  itself,  with  the  loss  of  a  very  few  days'  interest. 
Financing  Our  Exports  of  Cotton. — Cotton,  when  ex- 
ported from  the  United  States,  is  financed  in  a  compara- 
tively simple  manner.  The  cotton  importer,  or  buyer, 
arranges  with  a  London  bank,  for  example,  to  accept  drafts 
drawn  against  it  up  to  a  certain  amount.  When  this  is 
done,  the  foreign  cotton  buyer  makes  arrangements  with 
certain  dealers  to  cable  him  offers  of  cotton.  If  the  offers 
seem  attractive  they  are  accepted  by  cablegram,  in  which  is 
stated,  for  the  benefit  of  the  American  seller,  the  name  of 
the  foreign  bank  on  which  the  drafts  of  the  seller  are  to  be 
drawn.  The  American  seller  ships  the  cotton  to  the  foreign 
buyer  under  bills  of  lading  drawn  to  the  order  of  the 
American  shipper,  and  endorsed  by  them  in  blank.  These 
bills  of  lading  are  attached  to  drafts  drawn  upon  the  bank 
designated  in  the  cablegram.  The  draft  is  usually  at  sixty 
or  ninety  days. 

This  exchange  is  then  handled  in  one  of  two  ways :  First, 
it  may  be  sold  to  a  local  bank,  say  in  New  Orleans.  The 
course  of  the  transaction  from  this  point  on,  should  this 
alternative  be  selected,  was  described  by  Mr.  Wexler  before 
the  House  Committee  as  follows: 

"  We  remit  these  bills  as  we  buy  them — maybe  a 
million  or  a  million  and  a  half  a  week — to  Europe; 
and  we  sell  against  them  checks  payable  on  demand 
at  sight  in  New  York,  against  the  balances  which  our 
remittance  abroad  has  created.  When  we  sell  them  in 
New  York  we  receive  credit  in  New  York.  That  money 
may  remain  there  a  day,  or  it  may  remain  there  a  week. 


122      OPERATION  OF  THE  NEW  BANK  ACT 

or  it  may  remain  there  a  month.  We  check  against  it 
in  the  ordinary  course  of  business.  That  money  is 
lying  in  New  York  and  should  pay  a  reasonable  rate 
of  interest,  say  two  per  cent.  In  turn,  when  a  bank 
in  the  interior,  say  at  Mobile,  where  we  have  a  number 
of  bank  accounts,  gets  exchange  upon  New  Orleans, 
they  send  that  over  to  us  and  receive  credit  for  it,  and 
they  cheek  against  it  in  the  ordinary  course  of  busi- 
ness ;  and  as  long  as  they  are  receiving  a  small  rate  of 
interest  on  it  there  is  no  great  tendency  for  the  bank 
to  force  its  money  out.  They  can  better  afford  to  wait 
until  the  business  offered  them  is  entirely  satisfactory, 
because  they  are  getting  a  small  remuneration  upon  it 
while  it  remains  in  the  hands  of  the  other  banks. ' ' 

If  the  cotton  bills  are  not  sold  to  a  southern  bank  in  the 
manner  just  described,  they  are  in  all  probability  sold  in 
New  York  to  some  financial  institution,  such  as  the  Guaranty 
Trust  Company,  which  makes  a  business  of  buying  these 
bills.  They  are  forwarded  by  the  purchasing  New  York 
bank  to  its  London  correspondent,  and  against  the  credit 
thereby  built  up,  exchange  on  London  may  be  sold. 

Financing  Our  Imports. — As  regards  the  import  trade, 
it  is  almost  impossible  to  set  forth  any  typical  transaction. 
Trade  conditions  differ  widely;  and  to  add  still  further  to 
the  complexity  of  the  problem,  the  methods  of  financing 
transactions  differ  to  a  very  considerable  degree  as  between 
the  several  countries  of  the  world,  and  even  between  the 
large  cities  of  many  countries.  The  transaction  heretofore 
outlined  concerning  the  importation  of  coffee  is  fairly  typi- 
cal of  the  method  followed  in  financing  the  importation  of 
a  large  proportion  of  the  raw  materials  coming  to  us  from 
abroad.  American  importers  buy,  in  the  great  majority  of 
cases,  on  commercial  letters  of  credit  issued  by  London 
banks,  which  have  been  procured  by  the  American  importer 
through  his  local  American  bank.  The  American  institu- 
tion, acting  as  agent  for  the  foreign  bank,  will  sell  him  the 
letter  of  credit.     Armed  with  such  a  credit,  the  American 


FOREIGN  ACCEPTANCES  123 

manufacturer  is  able  to  buy  goods  on  a  cash  basis ;  for  the 
foreign  exporters  and  wholesalers  have  absolute  confidence 
in  the  London  house  which  is  obligated  by  the  letter  of 
credit  and  know  that  they  will  be  able  to  dispose  of  the  bill 
of  exchange  drawn  against  that  credit,  because  of  the  high 
standing  of  the  European  bank. 

Disadvantages  of  our  Methods. — From  the  stand-point 
of  the  American  banker,  however,  the  transaction  is  far  from 
satisfactory.  The  letter  of  credit  is  sold  on  the  basis  of 
sterling  exchange,  that  is  to  say,  it  entitles  the  bearer  to 
draw  drafts  up  to  a  stated  number  of  pounds  sterling,  and 
the  draft  or  bill  of  exchange,  when  drawn,  reads  in  pounds 
sterling.  To  the  American  firm,  this  introduces  an  unfamil- 
iar element  which  is  vexatious,  and  also  carries  with  it  cer- 
tain disadvantages.  Of  far  greater  importance  to  the 
banker,  however,  is  the  fact  that  in  selling  the  letter  of 
credit  he  gets  for  himself  only  one-half  of  the  commission 
charged  the  customer,  the  balance  going  to  the  European 
bank  whose  name  and  credit  are  being  used,  whereas  the 
American  bank  is  assuming  all  the  risk.  The  American 
banker  feels  that  if  he  can  sell  his  own  draft,  he  would  get 
the  entire  commission,  and  that  thereby  his  profits  would 
be  at  least  doubled  with  existing  rates.  He  can  not  do  so, 
however,  because,  as  we  have  seen,  the  name  of  the  American 
banker  is  not  known  and  such  drafts  can  not  be  advan- 
tageously negotiated  by  European  exporters  in  the  discount 
markets  of  England,  France  and  Germany.  The  American 
importer,  therefore,  insists  upon  a  sterling  draft  because  of 
the  better  terms  that  he  can  drive  with  it  in  his  bargain  with 
the  exporter.  The  demand  for  the  privilege  of  accepting 
foreign  bills  is  prompted,  to  a  large  degree,  by  the  desire 
of  the  American  banker  to  secure  the  entire  commission, 
rather  than  pay  half  of  it  to  his  European  correspondent. 

Rediscounting  and  Accepting  not  Favored, — Hereto- 
fore it  has  been  considered  the  height  of  bad  banking  for  an 
American  institution  to  endorse  the  paper  of  a  firm  where 
it  was  not  absolutely  necessary  in  the  conduct  of  the  bank's 
business.     This  has  been  the  chief  objection  to  discounts. 


124       OPERATION  OF  THE  NEW  BANK  ACT 

If  rediscounting  is  bad  practice,  accepting  is  much  worse; 
for  in  the  first  case  the  bank  gains  a  positive  advantage 
through  converting  a  note  into  cash,  while,  in  the  second, 
the  only  thing  which  would  justify  the  practice  is  the  com- 
paratively small  commission, — in  Europe  ranging  from  one- 
fourth  to  one-half  of  one  per  cent, — which  the  bank  would 
receive  for  lending  its  credit  to  merchants.  The  bank  doing 
an  acceptance  business  becomes,  in  substance,  a  professional 
endorser.  Of  course,  it  must  not  be  inferred  that  the  bank 
takes  a  large  risk  when  the  business  has  been  intelligently 
managed.  The  very  smallness  of  the  commission  shows  how 
slight  is  the  risk. 

Limitations  in  the  New  Law. — It  will  be  noted  that 
the  Federal  Reserve  Act  limits  the  amount  of  acceptances 
upon  which  the  bank  may  assume  obligation  to  an  amount 
equal,  in  the  aggregate,  to  not  more  than  one-half  of  its 
paid-up  capital  stock  and  surplus.  This  restriction  was 
prompted  by  the  demands  of  safety;  the  American  banker 
has  had  no  experience  in  the  acceptance  business,  and  even 
after  every  allowance  is  made  for  his  aciunen,  caution  and 
skill,  the  framers  of  the  law  felt  that  this  new  kind  of  bank- 
ing business  should  be  inaugurated  cautiously.  This  limi- 
tation, however,  will  not  very  much  restrict  the  extent  to 
which  such  a  business  can  be  developed. 

The  National  City  Bank  of  New  York,  the  largest  bank 
in  the  United  States,  with  deposits  of  almost  $200,000,000, 
has  an  aggregate  capital  and  surplus  of  $50,000,000.  Ac- 
cording to  the  limitation  imposed  by  the  Reserve  Act,  the 
National  City  Bank  could  not  have  outstanding  acceptances 
aggregating  over  $25,000,000.  "While  it  can  not  be  definitely 
stated,  yet  it  is  verj'^  probable  that  the  average  period  of 
paper  which  will  be  accepted  by  the  National  City  Bank 
will  be  about  sixty  days.  Upon  this  basis,  the  aggregate 
amount  of  exchange  which  the  National  City  Bank  could 
accept  in  a  year  would  be  $150,000,000.  It  is  very  unlikely 
that  any  single  institution  would  have  the  opportunity  to  do 
a  larger  business  than  this.     Certainly,  at  least,  it  would 


FOREIGN  ACCEFfANCES  125 

take  many  years  for  the  National  City  Bank  to  build  up 
an  acceptance  business  of  this  volume. 

Development  of  Accepting  in  the  United  States. — The 
general  sentiment  of  the  bankers  of  the  country  who 
appeared  before  the  Congressional  committees  was  that 
the  foreign  acceptance  business  will  not  immediately  have  a 
large  development.  Mr.  Sol  Wexler,  Vice-President  of  the 
Whitney  Central  National  Bank  of  New  Orleans,  an  institu- 
tion dealing  very  largely  in  foreign  exchange,  favored  the 
granting  of  the  privilege  of  acceptance  to  the  American 
bankers  in  order  that  we  may  be  in  a  position  to  compete, 
if  possible,  with  foreign  institutions  in  financing  our  foreign 
trade.  He  said:  "I  think  we  should  be  permitted  to  do  that 
business.  I  think  it  would  be  desirable  to  build  up  in  this 
country  an  acceptance  business  as  has  been  done  in  Europe. 
It  would  give  two-  or  three-name  paper  which  we  have  not 
got  to-day."  Mr.  Wexler  believes,  however,  that  the  inau- 
guration of  the  business  should  be  done  very  cautiously. 

]\Ir.  Andrew  J.  Frame,  President  of  the  Waukesha  Na- 
tional Bank,  Waukesha,  Wisconsin,  in  his  prepared  state- 
ment before  the  House  Committee,  stated : 

''Giving  7,400  national  banks  the  right  to  expand 
their  credit,  as  now  authorized,  to  the  limit  of  their 
assets;  then  loan  their  credit  by  accepting  customers' 
time  drafts  on  them ;  then  permitting  those  customers 
to  peddle  such  acceptances  in  any  money  market,  is 
entirely  unnecessary  and  also  a  dangerous  proposition. 
This  is  brokerage  and  not  legitimate  banking  and 
should  be  confined  to  acceptance  or  discount  houses 
making  it  their  business,  and  not  to  7,400  banks  of 
deposit. 

"When  we  find  in  the  Comptroller  of  the  Currency 
reports  for  1912  that  the  total  'loans  and  discounts' 
including  other  securities,  except  United  States  bonds, 
of  all  the  banks  of  the  United  States  approximate 
$18,500,000,000,  divided  about  as  follows,  to  wit : 


126      OPERATION  OF  THE  NEW  BANK  ACT 

In   various   classes   of   bonds,   etc,   excluding   United 

States   bonds    $4,500,000,000 

Real    estate    loans    and    mortgages    3,500,000,000 

Demand  and  time  loans  with  various  collateral  and 

single   or   firm   paper,  unsecured    6,000,000,000 

Live  commercial   paper,   say    4,500,000,000 

Total     $18,500,000,000 

we  are  led  to  exclaim,  with  nearly  one-half  of  the  total 
bank  loans  in  long-time  bonds  and  mortgages;  with 
nearly  one-third  in  various  non-quick  liquid  assets; 
and  only  one-quarter  of  it,  which  is  promptly  cared  for, 
in  live  commercial  paper,  including  shipments  with  bill 
of  lading  attached,  why  should  the  air  be  surcharged 
with  plans  to  manufacture  acceptances  in  order  to 
create  a  discount  market  for  idle  funds?  We  think 
the  proposition  absurd.  The  only  way  to  create  legiti- 
mately a  larger  discount  market  is  to  enlarge  our  inter- 
nal and  external  commerce ;  expand  by  hook  or  crook 
this  external  commerce,  not  indirectly  as  now  done 
largely  through  London,  but  through  direct  shipments 
to  and  from  the  world's  ports.  When  this  is  accom- 
plished, American  international  banking  will  pulsate 
quickly  throughout  the  world,  thus  turning  trade  and 
profits  from  London,  Paris,  Berlin,  etc.,  to  American 
ports ;  we  must  also  accumulate  surplus  capital  to  com- 
pete with  European  low  interest  rates  so  that  our  live 
bill-of-lading  paper  does  not  automatically  go  abroad. 
There  is  no  other  sound  cure.  Fictitious  manipulation 
through  internal  manufactured  acceptances  simply 
spells  bubble  blowing." 

Mr.  Frame's  criticism,  however,  was  based  largely  upon 
the  proposition  to  allow  member  banks  to  accept  domestic 
drafts.  This  proposal  was  almost  universally  condemned 
by  bankers,  and  was  stricken  from  the  bill  by  the  Senate 
Committee.  Mr.  Frame  believes  that  "a  live  acceptance 
with  a  bill  of  lading  attached  for  export  abroad  is  a  per- 
fectly legitimate  loan,  and  I  say  it  is  taken  care  of  now; 
therefore,  when  you  come  to  the  question  of  saying  that  you 


FOREIGN  ACCEPTANCES  127 

can  manufacture  a  lot  of  acceptances  to  create  a  discount 
market,  I  say  it  is  practically  impossible  to  do  it." 

Opinions  of  Leading  Bankers. — Practically  every 
banker  who  appeared  before  the  committee  in  the  matter 
of  acceptances  agreed  with  the  latter  part  of  I\Ir.  Frame's 
statement  that  we  can  not  build  up  an  acceptance  market 
simply  by  legalizing  the  practice.  If  the  American  banks 
are  to  have  a  large  acceptance  business,  it  must  be  as  the 
result  of  the  development  of  a  large  foreign  trade  to  be 
financed.  The  acceptance  business  is  the  result  of  the  trade. 
In  addition,  it  is  difficult  to  see  how  American  bankers  can 
make  much  headway  in  developing  their  acceptance  business 
until  they  can  succeed  in  establishing  a  ready  market  for  the 
paper  which  they  have  accepted  in  the  discount  markets  of 
Europe.  If  European  buyers  of  commercial  paper  continue 
to  look  with  relative  disfavor  upon  it,  as  they  have  done 
in  the  past,  then  it  will  be  difficult,  if  not  impossible,  to  get 
American  importers  to  take  "dollar  drafts"  and  to  arrange 
to  finance  their  transactions  entirely  through  their  Ameri- 
can banks  rather  than  to  follow  their  present  method.  It  is 
very  probable  that,  as  time  goes  on,  certain  American  banks 
will  establish  a  high  credit  rating  abroad  and  their  accept- 
ances will  sell  readily.  To  what  extent  this  will  be  true  is 
a  matter  which  can  not  be  foretold.  In  any  event,  one  thing 
is  certain :  the  great  rank  and  file  of  the  banks  of  the  United 
States  can  never  take  advantage  of  the  new  privilege  of 
accepting  foreign  bills,  for  they  do  no  business  which  would 
give  rise  to  such  transactions.  The  banks  which  will  build 
up  an  acceptance  business  are  comparatively  few  in  num- 
ber. They  will  be  institutions  situated  in  New  York,  Pliila- 
delphia,  Boston,  Chicago  and  other  centers  in  which  foreign 
trade  is  carried  on.  To  them,  the  right  of  accepting  is  an 
advantage ;  but  as  to  how  great  the  practical  benefit  will  be, 
it  is  impossible  to  make  any  intelligent  prediction. 

Accepting  as  an  Aid  to  Our  Foreign  Trade. — There  is 
another  side  to  the  question  of  foreign  acceptances  which 
deserves  a  moment's  consideration.  If  the  American 
bankers  succeed  in  developing  an  acceptance  business,  will 


128      OPERATION  OF  THE  NEW  BANK  ACT 

this  be  of  assistance  to  the  American  firms  in  the  develop- 
ment of  foreign  import  and  export  trade?  The  following 
excerpt  from  the  report  of  Archibald  J,  Wolfe  on  "Foreign 
Credits,"  published  by  the  United  States  Department  of 
Commerce  and  Labor,  is  interesting  as  bearing  upon  this 
matter : 

"Is  the  American  Manufacturer  at  a  Disadvan- 
tage? 

' '  The  question  whether  the  American  manufacturer 
is  or  is  not  at  a  disadvantage  in  discounting  his  bills 
on  foreign  countries,  as  compared  with  the  German 
and  the  British  manufacturers,  is  a  difficult  one  to  an- 
swer by  "yes"  or  "no."  When  reference  is  made  to 
individual  transactions,  it  will  be  found  that  an  Ameri- 
can manufacturer  of  standing  will  have  no  trouble  in 
having  his  ordinary  bills  on  most  foreign  countries  dis- 
counted by  American  bankers,  or  the  New  York  agents 
of  foreign  banks,  or  he  has  the  choice  of  sending  his 
bills  for  collection  to  the  banks  located  in  foreign 
points ;  and  it  is  apparent  that  in  either  case  the  cost  of 
the  transaction  to  him  is  no  greater  than  to  the  German 
or  to  the  British  shippers.  It  is  in  the  general  system 
of  financing  foreign  shipments,  as  described  in  the 
chapters  on  German  and  British  methods,  that  the 
Europeans  have  the  advantage.  The  elastic  system 
which  permits  banks  to  accept  bills  drawn  on  them  by 
their  customers,  who  can  have  these  bills  rediscounted, 
the  existence  in  Germany  and  in  England  of  authorita- 
tive institutions  laying  down  the  discount  and  loan 
rates  which  automatically  guide  the  entire  banking 
system  in  its  dealings  with  individual  clients,  and 
finally  the  presence  of  an  open  discount  market  which 
permits  bankers  to  employ  funds  in  the  purchase  of 
bankers'  and  prime  merchants'  bills  and  to  rediscount 
the  same  when  cash  funds  are  needed — these  are  among 
the  principal  aids  to  a  freer  system  of  financing  the 
foreign  business  than  that  prevailing  in  the  United 
States.     In  the  United  States  paper  discounted  for  a 


FOREIGN  ACCEPTANCES  129 

bank's  customers  is  held  until  maturity  and  is  so  much 
dead  weight  in  the  bank's  vaults,  the  operations  be- 
ing, therefore,  necessarily  restricted;  in  fact,  it  is  only 
because  American  bankers  are  able  to  discount  bills 
purchased  from  American  exporters  in  the  foreign 
money  markets  that  they  are  at  all  in  a  position  to 
negotiate  such  bills  for  their  customers. 

"  In  the  scope  of  this  report  banking  may  be  com- 
mented upon  only  to  the  extent  of  entering  into  the 
question  of  financing  foreign  shipments.  Yet  one  feat- 
ure of  the  proposed  improvements  in  our  banking  sys- 
tem can  not  be  left  undiscussed.  We  are  advised  to 
start  banks  in  foreign  countries.  The  vast  impor- 
tance to  German  commerce  of  the  many  German  banks 
in  Latin  America  and  in  the  Far  East  is  readily 
admitted.  There  are,  however,  important  drawbacks 
in  such  undertakings.  Banks  alone  can  not  create 
trade.  France  has  numerous  bank  agencies  in  Russia, 
while  Germany  has  practically  none,  and  yet  Germany 
dominates  the  trade  of  Russia.  If  we  had  a  chain 
of  banks  in  Latin  America,  would  they  be  employed 
for  banking  transactions  with  Latin  America  or  in 
Latin  America  ?  What  disastrous  effect  might  not  the 
failure  of  such  a  branch,  due  to  some  local  causes,  have 
upon  the  mother  bank  in  the  United  States?  It  seems 
that  far  the  better  plan  might  be  to  create  connections 
by  taking  an  interest  in  existing  Latin-American  banks. 
The  risk  would  be  limited  only  to  the  amount  invested, 
and  practically  every  other  benefit  of  American-owned 
banks  abroad  would  be  secured." 


CHAPTER  XII 

Eetiring  the  National  Bank  Notes 

The  National  Bank  Notes  Unsatisfactory. — One  of  the 
most  difficult  of  the  problems  to  be  solved  by  the  new  bank- 
ing law  is  the  question  of  note  issues.  Our  national  bank 
notes,  for  reasons  explained  earlier  in  this  volume,  have 
been  unsatisfactory.  Although  entirely  safe  they  have  been 
inelastic,  increasing  and  decreasing  in  amount  not  with 
the  needs  of  business,  but  with  fluctuations  in  the  price  of 
the  United  States  bonds  with  which  they  are  secured.  Their 
subordination  has  clearly  been  one  of  the  essentials  in  any 
plan  for  reform,  and  must,  of  course,  be  accompanied  by 
the  introduction  of  a  new  and  more  satisfactory  note. 

These  Notes  Hard  to  Eliminate. — The  double  problem 
of  retiring  the  old  notes  and  of  substituting  new  ones  that 
will  be  more  satisfactory  has  been  harder  to  solve  than 
almost  any  other.  The  present  notes  are  a  definite  part  of 
our  monetary  supply  in  the  hands  of  the  people  and  in  the 
vaults  of  some  of  the  banks,  especially  the  State  institu- 
tions. A  sudden  withdrawal  of  them  would  mean  a  shrink- 
age of  approximately  $750,000,000  in  our  supply  of  money, 
which  would  cause  serious  inconvenience  and  even  great 
hardship  to  those  who  would  suffer  from  the  scarcity  of 
ready  cash  and  the  resulting  contraction  of  business  that 
is  based  on  that  cash.  Moreover,  the  bonds  securing  those 
notes  have  been  purchased  by  the  banks  from  time  to  time, 
over  a  long  period  of  years.  High  prices  have  been  paid 
for  many  of  them,  not  because  of  their  value  for  ordinary 
investment  purposes,  but  because  each  bank  was  required 
(1)  before  commencing  business  to  buy  and  deposit  in 
trust  with  the  United  States  Treasurer  at  Washington  an 
amount  of  these  bonds  that  bore  a  definite  relation  to  the 
amount  of  its  capital,  and  (2)  to  add  to  this  deposit  at 
Washington  an  amount  sufficient  to  make  the  total  equal 
130 


RETIRING  NATIONAL  BANK  NOTES         131 

to  the  araoimt  of  the  circulating  notes  it  might  decide  to 
issue.  These  requirements  have  been  such  a  stimuhis  to 
the  demand  for  the  bonds  that  their  prices  have  risen  much 
higher  than  woukl  otherwise  have  been  the  case.  For  some 
time  past  there  has  been  a  decline  in  bond  quotations,  and 
a  sudden  retirement  of  the  national  bank  notes  would  mean 
a  further  very  sharp  drop  and  a  consequent  heavy  loss  to 
the  national  banks.  Inasmuch  as  the  oovernment  has  re- 
quired the  purchase  of  many  of  them,  and  has  made  the 
purchase  of  the  rest  a  prerequisite  to  the  issue  of  circula- 
tion, Congress  was  bound  to  make  some  provision  against 
such  a  heavy  loss. 

Any  legislation  that  might  be  enacted  governing  the 
issue  of  a  new  kind  of  note  involved  two  considerations. 
First,  the  subordination  of  the  old  national  bank  notes  and 
the  substitution  for  them  of  a  new  supply  of  money  which 
shall  be  a  somewhat  permanent  part  of  the  circulation ;  and, 
second,  the  issue  of  other  notes  whose  supply  shall  be 
elastic,  varying  with  the  fluctuations  in  the  demands  of 
business.     We  shall  examine  these  two  problems  in  order. 

The  Need  for  a  Circulating  Medium. — Before  analyz- 
ing the  provisions  of  the  new  act  several  rather  funda- 
mental considerations  must  be  made  clear.  There  is  a  cer- 
tain amount  of  money  that  is  always  necessary  for  the  daily 
needs  of  business.  There  are  fluctuations  in  this  amount, 
but  there  io  a  minimum  below  which  our  needs  for  bank 
reserves  and  for  a  circulating  medium  can  not  fall.  Pro- 
fessor 0.  M.  W.  Sprague,  in  his  testimony  before  the  United 
States  Senate  Committee  on  Banking  and  CuiTency,  con- 
sidered that  from  $1,200,000,000  to  $1,500,000,000  is  per- 
manently needed  by  the  people  of  the  United  States  as  a 
circulating  medium,  entirely  aside  from  the  amounts  held 
in  the  vaults  of  the  banks. 

On  December  1,  1913,  we  had  in  the  Ignited  States 
$3,767,082,704,  of  which  $332,832,015  was  held  in  the  Treas- 
ury as  assets  of  the  government,  and  the  balance,  or  $3,434,- 
249,789,  was  in  the  banks  or  in  the  hands  of  the  public.  To 
this  supply  of  money  the  business  of  the  country  was  ad- 


132      OPERATION  OF  THE  NEW  BANK  ACT 

justed.  Any  considerable  increase  or  decrease  would  be 
felt,  perhaps  injuriously.  Of  this  total  the  greenbacks  and 
the  silver  dollars  are  absolutely  fixed  in  amount.  Silver 
certificates,  of  course,  merely  represent  silver  dollars  and 
fluctuate  inversely  with  them.  Subsidiary  silver  is  of  minor 
importance,  as  are  also  the  Treasury  notes  of  1890.  Gold, 
and  the  gold  certificates,  may  change  in  amount  because  of 
a  greater  output  of  gold  from  the  mines,  and  through  im- 
ports and  exports,  but  the  great  mass  of  it  is  a  permanent 
part  of  our  circulation.  In  brief,  no  increase  in  any  of 
these  other  forms  of  money  could  readily  or  wisely  be  pro- 
vided to  take  the  place  of  our  $756,944,194  national  bank 
notes  should  they  be  withdrawn.  Yet  their  place  must  be 
filled  unless  we  expect  business  to  readjust  itself  some- 
what violently  to  a  changed  supply  of  money.  This  sub- 
stitution should  be  accomplished  in  such  manner  as  to  avoid 
heavy  losses  to  the  national  banks  through  a  fall  in  the 
value  of  their  United  States  bonds. 

Many  different  plans  have  been  proposed.  Perhaps  some 
of  them  were  better  than  the  one  finally  adopted,  but  this 
is  not  the  place  for  comparisons.  A  definite  program  has 
been  decided  upon  by  Congress  and  on  this  our  attention 
must  be  concentrated.  The  plan  will  be  stated  briefly,  fol- 
lowed by  a  discussion  of  its  effects  upon  the  Federal  reserve 
banks  and  upon  the  national  banks. 

National  Banks  May  Continue  to  Issue  Notes. — The 
Federal  Reserve  Act  does  not  compel  the  national  banks 
to  retire  their  outstanding  circulation.  They  may  increase 
it  or  decrease  it  under  the  old  regulations  and  ^vithin  the 
old  limits,  if  they  see  fit.  Moreover,  they  are  released  by 
Section  17  of  the  Act  from  the  old  requirement  to  purchase 
a  stated  amount  of  United  States  bonds  before  being  author- 
ized to  commence  the  banking  business. 

Retiring  the  National  Bank  Notes. — The  first  impor- 
tant change  is  that,  beginning  two  years  after  the  passage 
of  the  Act,"  that  is  to  say  on  December  23,  1915,  member 
banks  may  retire  their  circulation  in  whole  or  in  part,  this 


RETIRING  NATIONAL  BANK  NOTES        133 

privilege  to  remain  open  for  a  period  of  twenty  years  there- 
after, or  until  December  23,  1935.  Any  member  bank 
desiring  to  retire  any  or  all  of  its  circulating  notes  may 
file  with  the  Treasurer  of  the  United  States  an  application 
to  sell  for  its  account,  at  par  and  accrued  interest,  its  United 
States  bonds,  now  held  in  trust  at  Washington  against  the 
circulation  that  is  to  be  retired.  Such  application  should 
be  filed  at  least  ten  days  before  the  end  of  each  quarterly 
period  in  order  to  secure  prompt  action.  If  this  condition 
is  not  observed,  the  application  will  not  be  acted  upon  until 
the  end  of  the  next  quarterly  period. 

At  the  end  of  each  quarterly  period — March  31,  June 
30,  September  30  and  December  31 — the  Treasurer  shall 
furnish  a  list  of  such  applications  to  the  Federal  Reserve 
Board,  which  may,  at  its  discretion,  require  the  Federal 
reserve  banks  to  purchase  these  bonds  at  par  and  accrued 
interest.  Each  reserve  bank  shall  have  allotted  to  it  by  the 
Reserve  Board  such  proportion  of  the  bonds  as  its  capital 
and  surplus  bear  to  the  aggregate  capital  and  surplus  of 
all  the  reserve  banks. 

Disposition  of  the  United  States  Bonds. — The  Treas- 
urer shall  notify  the  member  banks  of  the  amount  of  bonds 
sold  for  their  account  and  these  banks  shall  then  assign 
and  transfer  the  bonds  to  the  reserve  bank  that  has  pur- 
chased them.  The  reserve  banks  shall  then  deposit  lawful 
money  with  the  Treasurer  of  the  United  States  for  the  pur- 
chase of  the  bonds.  The  Treasurer  shall  deduct  from  this 
payment  an  amount  sufficient  to  redeem  the  outstanding 
national  bank  notes  that  have  in  the  past  been  secured  by 
those  bonds,  and  shall  pay  the  balance,  if  any  remains,  to 
the  member  bank  that  formerly  owned  them. 

Advantages  of  the  Plan. — From  the  standpoint  of  the 
national  bank  this  arrangement  has  one  advantage  and 
several  disadvantages.  The  advantage  is  that  the  bonds  it 
now  holds  may  be  sold  at  par.  ]\Iost  of  them  pay  only  two 
per  cent  and  yield  even  less  on  the  basis  of  the  purchase 
price,  since  they  were  purchased  at  a  considerable  premium. 


134       OPERATION  OF  THE  NEW  BANK  ACT 

The  market  price  has  for  several  months  past  been  below  par 
and  this  provision  in  the  Act  may  strengthen  the  market. 

Objectionable  Features, — On  the  other  hand,  there  are 
several  disadvantages.  In  the  first  place,  no  provision  is 
made  for  non-member  national  banks.  If  they  wish  to  re- 
tire their  circulation  they  must  do  it  as  in  the  past.  Since 
national  banks  must  become  members  by  December  23,  1914, 
or  forfeit  their  charters,  failure  to  enter  the  system  involves 
the  necessity  of  depositing  lawful  money  at  Washington 
for  the  redemption  of  their  circulation.  This  step  would 
leave  them  with  the  bonds  on  their  hands  to  dispose  of  in 
the  best  way  possible.  The  offering  of  any  considerable 
number  would  seriously  break  the  market.  A  suggestion  of 
how  serious  this  might  be  is  to  be  found  in  the  fact  that 
British  two  and  one-half  per  cent  consols  are,  at  the  time 
of  this  writing,  worth  about  72,  and  French  three  per  cent 
rentes,  86.  Our  own  Panama  three  per  cent  bonds,  which  are 
not  available  to  secure  circulation,  are  selling  at  about  par. 
Over  ninety  per  cent  of  our  national  bank  notes  are  secured 
by  two  per  cent  bonds,  and  just  how  low  the  market  for 
these  would  fall,  if  many  were  offered,  is  a  matter  for  con- 
jecture. In  view  of  the  tendency  to  urge  the  banks  to  join 
the  system,  it  seems  improbable  that  the  Treasury  Depart- 
ment would  take  any  definite  steps  to  support  the  market, 
merely  to  prevent  loss  to  those  banks  that  are  unwdlling  to 
enter. 

Retirement  Will  Be  Slow, — Another  disadvantage  in 
the  arrangement  is  that  the  inauguration  of  the  plan  for  re- 
tirement is  delayed  until  December  23,  1915.  Any  bank  that 
wishes  or  is  compelled  to  retire  its  circulation  prior  to  that 
time  must  dispose  of  its  bonds  in  the  market  at  the  current 
quotations.  Besides,  the  retirement  can  not  be  very  rapid 
even  after  it  has  started.  The  reserve  banks  are  not  al- 
lowed to  purchase  more  than  $25,000,000  of  these  bonds  in 
any  one  year,  and  even  this  amount  may  be  reduced  if  they 
choose  to  purchase  bonds  under  the  authorization  in  Sec- 
tion 4,  which  will  be  explained  in  the  next  chapter. 

There  were  outstanding  on  December  26,  1913,  $756,- 


RETIRING  NATIONAL  BANK  NOTES         135 

944,194  of  national  bank  notes,  against  which  were  held  $16,- 
147,911  of  lawful  money  and  $743,173,000  of  United  States 
bonds.  If  all  the  national  banks  make  application  regularly 
and  the  full  $25,000,000  be  taken  over  by  the  Federal  reserve 
banks  each  j^ear,  the  process  will  take  nearly  thirty  years. 
Any  bank  liquidating  its  affairs  in  the  interv^al  will  be  com- 
pelled to  dispose  of  its  bonds  in  the  market  and  assume 
any  resulting  loss.  This  could  be  obviated  if  the  Reserve 
Board  should  give  preference  to  such  banks  under  the  plan 
for  retiring  the  national  bank  notes.  No  instructions  are 
given  in  the  Act  to  guide  the  Reserve  Board  in  the  amount 
it  must  require  the  reserve  banks  to  purchase  from  any 
particular  national  bank.  It  seems  probable  that  if  more 
than  $25,000,000  be  offered  in  any  one  year,  or  one-fourth 
of  that  sura  in  any  one  quarter  of  the  year,  the  board  will 
allow  each  bank  making  application  to  retire  an  amount  to 
be  determined  b.y  the  ratio  between  its  application  and  the 
total  applications  received,  or  will  in  some  other  way  work 
out  the  problem  on  a  pro  rata  basis. 

.  Complete  Retirement  not  Provided  For. — But  this  is 
not  all.  The  Act  specifically  hmits  the  retirement  process 
to  a  period  of  twenty  years.  Since,  as  we  have  seen,  it  would 
take  nearly  thirty  yeai-s,  at  the  rate  of  $25,000,000  a  year, 
to  retire  all  the  outstanding  notes,  each  bank  would  be  left 
at  the  end  of  that  long  period  with  approximately  one- 
third  of  its  ])onds  still  on  hand.  If  we  deduct  the  three  per 
cent  and  four  per  cent  T"^nited  States  bonds  now  held  in 
trust,  and  limit  ourselves  to  the  two  per  cent  bonds,  which 
amount  to  $685,996,700,  the  retirement  of  all  of  them  would 
take  over  twenty-seven  years  and  the  banks  would  be  left 
with  at  least  $185,996,700  unprovided  for. 

Profits  on  Note  Issues. — This  a.ssumes  that  the  national 
banks  will  wish  to  retire  their  outstanding  circulation,  and 
such  an  assumption  may  be  entirely  false.  The  Comp- 
troller of  the  Currency  and  otlmrs  have  worked  out  a 
formida  by  which  to  determine  the  profits  to  national  banks 
in  issuing  circulating  notes.  If  the  circulation  is  based  on 
the  deposit  of  $100,000  of  United   States   consols  of  1930 


136      OPERATION  OF  THE  NEW  BANK  ACT 

purchased  at  $101,255  (the  market  price  in  October,  1912) 
the  gross  receipts,  the  expenses  and  the  net  profit  would  be 
as  follows: 

Cost  of  bonds  $101,255.00 

Circulation  obtainable    100,000.00 

Receipts 

Interest  on  bonds   $2,000.00 

Interest  on  circulation  at  6  per  cent 6,000.00 

Gross  receipts $8,000.00 

Deductions 

Tax  on   circulation    $500.00 

Expenses 62.50 

Sinking  fund   41.02 

603.52 

Net  receipts    $7,396.48 

Interest  on  cost  of  bonds  at  6  per  cent 6,075.30 

Profit  on  circulation  in  excess  of  6  per  cent  on 

the  investment    $1,321.18 

Per    cent    profit 1.305 

This  estimate  is  a  comparative  one,  showing  that  a 
national  bank  gains  little  by  taking  out  bonds,  securing 
notes  and  lending  the  notes  at  the  current  rate  of  interest 
(assumed  to  be  six  per  cent),  rather  than  by  taking  the 
original  investment  of  $101,255  and  lending  it  at  the  same 
current  rate  of  interest. 

Reasons  for  Issuing  Notes. — Opinions  of  bankers  as 
to  the  profits  actually  gained  do  not  agree  with  this  calcu- 
lation, or  with  each  other.  The  calculation  assumes  that 
all  of  the  notes  are  kept  at  work  all  of  the  time,  which  is 
by  no  means  true,  for  to  do  this  is  not  always  easy.  Coun- 
try bankers  pay  their  own  notes  out  over  the  counter  or 
deposit  them  with  their  reserve  agents,  thus  indirectly 
placing  them  where  they  may  be  counted  as  a  part  of  their 
reserves.  Reserve  city  banks  do  the  same  and  these  two 
classes  of  institutions  are  in  this  way  able  to  keep  their 
circulation  moving.  As  rapidly  as  it  returns  to  them,  via 
the  redemption  agency  at  Washington,  it  is  again  sent  out. 
The  banks  in  the  central  reserve  cities,  however,  find  the 


RETIRING  NATIONAL  BANK  NOTES         137 

problem  a  little  more  difficult,  and  as  a  result  there  is,  ordi- 
narily, a  relatively  larger  margin  between  the  United  States 
bonds  held  by  them  at  Washington  and  the  amount  of  their 
notes  outstanding. 

Conversations  with  bankers  on  the  subject  reveal  a  dif- 
ference of  opinion  on  the  entire  question.  To  some  it  is 
simply  the  customary  and  expected  thing.  Others  consider 
that  there  is  some  profit  and  a  certain  amount  of  advertis- 
ing value  in  the  notes.  Probably  the  most  careful  would 
summarize  the  matter  by  saying  that  they  issue  notes  be- 
cause (1)  there  is  often  an  actual  though  small  financial 
gain;  (2)  a  slight  advantage  is  found  in  the  advertising; 
(3)  a  certain  amount  of  United  States  bonds  add  to  the 
appearance  of  the  bank's  balance  sheet,  suggesting  con- 
servative management  and  the  possession  of  a  reliable  sec- 
ondary reserve;  (4)  the  purchase  of  United  States  bonds  is 
one  way  to  cultivate  friendly  relations  with  the  United 
States  Treasury  Department;  (5)  in  the  past  some  bonds 
have  been  purchased  as  a  prerequisite  to  beginning  busi- 
ness on  which  it  is  sensible  to  issue  circulation ;  and  (6)  it  is 
customary.  The  motive  in  a  particular  case  is  a  composite 
one  made  up  of  several  or  all  of  the  ones  given  above. 

The  Policy  of  the  Banks  Uncertain. — -Just  what  will 
be  in  the  future  the  attitude  of  bankers  in  this  matter  is  un- 
certain. Many  may  wish  to  continue  their  issues.  If  United 
States  bonds  remain  low  in  price,  their  cheapness  may  be  a 
temptation  as  in  the  past.  The  banks  may  actually  be  en- 
couraged to  issue  notes.  If,  however,  they  fear  that  the  pur- 
chases by  the  new  reserve  banks  will  be  insufficient  to  sus- 
tain the  mai'ket,  they  may  prefer  to  retire  their  issues  as 
promptly  as  possible.  Within  the  last  year  some  have  retired 
circulation  apparently  to  guard  against  the  possibility  of 
loss  by  reason  of  the  low  mai'ket  price  of  the  bonds  securing 
their  notes.  In  other  eases  tlie  directors  have  hesitated  in 
the  hope  that  the  market  would  recover.  ^Fany  newly  or- 
ganized banks  have  taken  out  the  full  amount  authorized 
and,  on  the  whole,  the  circulation  has  increased  from  $717,- 
467,6f51.50  on  February  4.  1013.  to  $756,944,194  on  Decem- 
ber 26,  1913.     The  future  is  too  uncertain  for  predictions. 


CHAPTER  XIII 

The  New  Reserve  Bank  Notes  and  Refunding  the  Bonds 

The  Need  for  Reserve  Bank  Notes. — The  retirement 
of  the  national  bank  notes  would  leave  a  large  gap  in  our 
supply  of  money  and,  unless  some  provision  were  made  for 
filling  it,  great  inconvenience  and  much  actual  distress 
would  result.  Accordingly  the  Act  authorizes  the  issue  of 
notes  by  the  reserve  banks.  These  are  not  to  be  confused 
with  the  Federal  reserve  notes  described  later,  as  they  are 
entirely  different  in  form  and  in  security. 

Reserve  bank  notes  are  to  be  the  obligations  of  the 
Federal  reserve  bank  issuing  them  and  "shall  be  in  form 
prescribed  by  the  Secretary  of  the  Treasury  and  to  the 
same  tenor  and  effect  as  national  bank  notes  now  provided 
by  law.  They  shall  be  issued  and  redeemed  under  the  same 
terms  and  conditions  as  national  bank  notes,  except  that 
they  shall  not  be  limited  to  the  amount  of  the  capital  stock 
of  the  Federal  reserve  bank  issuing  them. ' '  In  other  words, 
each  reserve  bank  may  issue  an  amount  of  these  notes  that 
is  limited  only  by  the  deposit  of  the  prescribed  security. 

Their  Similarity  to  National  Bank  Notes. — The  state- 
ment that  the  terms  and  conditions  of  their  issue  shall  be 
the  same  as  those  of  the  national  bank  notes  would  indicate 
that  these  new  notes  must  pay  the  same  tax.  The  circu- 
lating notes  of  the  national  banks  that  are  secured  by 
United  States  bonds  paying  two  per  cent  interest,  are  sub- 
ject to  a  Federal  tax  of  one-fourth  of  one  per  cent  each  half 
year,  which  amounts  to  one-half  of  one  per  cent  per  annum. 
The  notes  secured  by  Ignited  States  bonds  paying  more  than 
two  per  cent  interest  are  subject  to  a  similar  tax  of  one-half 
of  one  per  cent  semi-annually,  amounting  to  one  per  cent 
each  year.  It  would  seem  certain  that  this  tax  is  to  be  paid 
in  the  future  by  the  reserve  banks  on  their  bond-secured 
circulation  if  it  were  not  for  the  last  paragraph  of  Sec- 
138 


NEW  RESERVE  BANK  NOTES  139 

tion  7  of  the  new  law,  which  states  that  "Federal  reserve 
banks,  including  the  capital  stock,  and  surplus  therein,  and 
the  income  derived  therefrom,  shall  be  exempt  from  Federal, 
State  and  local  taxation,  except  taxes  upon  real  estate." 

Will  They  Be  Taxed? — Does  this  exemption  include 
the  tax  upon  circulation?  It  is  a  Federal  tax  and,  if  im- 
posed upon  the  new  bond-secured  circulation  of  the  reserve 
banks,  is  rather  obviously  a  tax  upon  the  reserve  banks. 
If  it  is  collected  from  the  national  banks,  as  in  the  past,  but 
not  from  the  reserve  banks,  the  latter  are  given  an  advan- 
tage of  at  least  one-half  of  one  per  cent  per  annum  in  the 
matter  of  note  issues,  a  difference  that  may  be  of  material 
importance.  In  the  preceding  chapter  attention  was  called 
to  the  small  margin  of  profit  to  the  national  banks  in  buying 
bonds  and  issuing  notes  rather  than  in  lending  their  money 
direct.  If  this  small  advantage  is  lessened  by  allowing  the 
reserve  banks  to  issue  notes  untaxed,  the  discrimination 
may  accelerate  the  retirement  of  the  national  bank  notes. 

Occasions  for  Issuing  Them. — Issues  of  bond-secured 
currency  of  the  Federal  reserve  banks  may  originate  in  two 
ways,  although  all  of  the  notes  will  be  alike  in  form  and  in 
security.  The  first  group  will  arise  through  the  retirement 
of  the  national  bank  notes.  The  provisions  of  the  Act  relat- 
ing to  the  purchase  by  the  reserve  banks  of  the  United  States 
bonds  that  now  secure  the  national  bank  notes  have  been 
explained.  At  a  rate  not  in  excess  of  $25,000,000  per  annum 
these  bonds  must  be  taken  over  if  they  are  offered,  and  if 
the  Federal  Reserve  Board  requires  their  purchase.  The 
reserve  banks  purchasing  them  may  deposit  them  in  trust 
with  the  Treasurer  of  the  United  States,  receiving  from  the 
Comptroller  of  the  Currency  an  amount  of  circulating  notes 
equal  to  the  par  value  of  the  bonds  so  deposited.  There  will 
thus  be  no  shrinkage  in  the  volume  of  the  currency,  the 
amount  of  new  reserve  bank  notes  being  equal  to  the  national 
bank  notes  that  are  retired.  The  net  result  will  be  to  relieve 
the  national  banks  of  the  ownership  of  the  bonds  and  their 
liability  for  the  notes,  and  to  transfer  both  the  bonds  and 
the  note  liability  to  the  reserve  banks. 


140      OPERATION  OF  THE  NEW  BANK  ACT 

The  second  way  iu  which  the  reserve  bank  notes  may 
get  into  circulation  is  under  the  provisions  of  Section  4. 
The  eighth  of  the  powers  conferred  upon  the  reserve  banks 
in  that  section  stipulates  that  they  may,  "upon  deposit  with 
the  Treasurer  of  the  United  States  of  any  bonds  of  the 
United  States  in  the  manner  provided  by  existing  law  relat- 
ing to  national  banks, ' '  receive  from  the  Comptroller  of  the 
Currency  circulating  notes  equal  in  amount  to  the  par 
value  of  the  bonds  so  deposited.  These  notes  are  identical 
with  the  ones  already  described,  the  only  difference  being 
that  in  the  first  case  the  bonds  are  the  ones  that  now  secure 
the  circulation  of  the  national  banks,  while  in  the  second 
the  bonds  may  not  have  been  securing  national  bank  cir- 
culation at  the  time  of  purchase,  and  may  have  been  bought 
from  other  owners  than  national  banks. 

A  Market  Created  for  United  States  Bonds. — The 
significance  of  this  provision  lies  in  the  fact  that  it  creates 
a  market  for  United  States  bonds.  This  power  of  the 
reserve  banks  may  be  of  value  in  maintaining  the  price  of 
the  bonds,  not  only  to  the  advantage  of  the  present  holders 
of  those  bonds  but  also  to  the  advantage  of  the  government. 
It  is  also  important  because,  if  this  power  is  exercised,  it  will 
limit  the  amount  of  United  States  bonds  that  the  reserve 
banks  may  purchase  from  the  national  banks  to  retire  their 
circulation.  The  total  amount  they  are  permitted  to  pur- 
chase from  both  sources  may  not  exceed  $25,000,000  per 
annum.  Most  of  our  government  bonds  are  in  the  hands 
of  the  national  banks.  The  owners  of  the  balance,  who  are 
the  trust  companies,  insurance  companies  and  the  general 
public,  may,  especially  if  the  market  declines,  dispose  of 
their  holdings  to  the  reserve  banks,  which  will  be  tempted 
by  the  low  prices  to  make  the  purchases,  since  they  may  ex- 
change them  at  the  Treasury  Department  for  new  three  per 
cent  bonds.  This  may  be  done  to  such  an  extent  as  to  lessen 
the  rapidity  with  which  those  banks  could  purchase  from 
the  national  banks. 

Refunding  the  Two  Per  Cent  Bonds, — If  the  reserve 
banks  do  not  wish  to  keep  these  notes  out,  and  wish  to 


NEW  RESERVE  BANK  NOTES  141 

invest  in  United  States  securities  bearing  more  than  two 
per  cent  interest,  they  may  do  so  through  an  arrangement 
for  an  exchange.  "Upon  application  of  any  Federal  reserve 
bank,  approved  by  the  Federal  Reserve  Board,  the  Secre- 
tary of  the  Treasury  may  issue  in  exchange  for  United 
States  two  per  cent  gold  bonds  bearing  the  circulation 
privilege,  but  against  which  no  circulation  is  outstanding, 
one-year  gold  notes  of  the  United  States  without  the  circu- 
lation privilege,  to  an  amount  not  exceeding  one-half  of  the 
two  per  cent  bonds  so  tendered  for  exchange,  and  thirty-year 
three  per  cent  gold  bonds  without  the  circulation  privilege 
for  the  remainder  of  the  two  per  cent  bonds  so  tendered." 
The  reserve  bank  may  thus  retire  its  note  issues  in  the  same 
way  as  the  national  banks  now  do,  and  then  make  an  ex- 
change in  the  manner  described,  getting  three  per  cent 
securities  in  return  for  those  bearing  two  per  cent.  The 
burden  of  the  additional  one  per  cent  per  annum  interest 
charge  will  fall  upon  the  government,  an  arrangement  that 
is  entirely  proper,  since  for  years  it  has  borrowed  at  rates 
lower  than  are  available  for  any  other  government  in  the 
world,  and  has  done  it  by  requiring  the  national  banks  to 
buy  the  bonds  as  a  prerequisite  to  securing  a  charter  and 
issuing  notes. 

The  Significance  of  the  One-year  Notes. — The  stipu- 
lation that  "not  to  exceed  one-half  of  the  new  securities 
shall  be  one-year  gold  notes"  opens  the  way  for  a  reduction 
in  the  national  debt,  if  receipts  to  the  Federal  government 
from  the  earnings  of  the  reserve  banks  or  from  any  other 
source  make  such  a  reduction  possible.  The  reserve  bank 
will  be  required,  upon  receipt  of  these  notes,  to  agree  that 
as  they  mature  year  after  year,  it  will  purchase  such  an 
amount  of  new  one-year  three  per  cent  gold  notes  as  the 
Secretaiy  of  the  Treasury  may  tender  to  it,  not  to  exceed, 
however,  the  amount  of  such  notes  issued  to  the  bank  in  the 
first  instance  in  exchange  for  the  two  per  cent  bonds.  This 
obligation  to  purchase  notes  shall  continue  for  a  period  not 
to  exceed  thirty  years.  At  the  end  of  that  time,  if  the 
Secretary  of  the  Treasury  and  Congress  do  not  find  it  pos- 


142      OPERATION  OF  THE  NEW  BANK  ACT 

sible  to  retire  these  notes,  some  provision  for  refunding  them 
can  bo  made. 

One-Year  Notes  to  Protect  Gold  Standard. — These 
one-year  notes  are  not  to  be  confused  witli  tlios*;  provided 
for  in  Section  26  of  the  Act,  which  reaffirms  the  Gold  Stand- 
ard Act  of  March  14,  1900,  and  further  provides  that 
the  "Secretary  of  the  Treasury  may,  for  the  purpose  of 
maintaining  such  parity  and  to  strengthen  the  gold  reserve, 
borrow  gold  on  the  security  of  United  States  bonds  ...  or 
for  one-year  gold  notes  bearing  interest  at  a  rate  of  not  to 
exceed  three  per  centum  per  annum,  or  sell  the  same  if  neces- 
sary to  obtain  gold.  When  the  funds  of  the  Treasury  on 
hand  justify,  he  may  purchase  and  retire  such  outstanding 
bonds  and  notes."  These  notes  differ  from  the  ones  first 
described  in  that  they  will  be  issued,  if  at  all.  to  strengthen 
the  Treasury  gold  reserve  behind  the  United  States  notes, 
the  silver  dollars  and  the  silver  certificates,  and  not  for  re- 
funding outstanding  two  per  cent  bonds,  and  also  in  that 
the  rate  of  interest  is  "not  to  exceed  three  per  centum," 
while  the  other  notes  pay  exactly  three  per  cent. 

The  Reduction  of  the  National  Debt. — Before  leaving 
this  topic  it  is  interesting  to  notice  that  our  new  law  has 
in  two  different  places  made  provision  for  the  reduction 
of  the  national  debt.  One-half  of  the  net  earnings  of  the 
reserve  banks,  after  the  payment  of  a  six  per  cent  cumu- 
lative dividend,  is  to  be  used  in  the  creation  of  a  surplus, 
until  such  time  as  this  surplus  equals  forty  per  cent  of  the 
paid-in  capital  stock  of  the  bank.  The  balance  of  the  net 
earnings  is  to  be  paid  as  a  franchise  tax  to  the  government, 
and  may  be  used  by  the  Secretary  of  the  Treasury,  at  his 
discretion,  to  strengthen  the  gold  reserve  behind  the  United 
States  notes  or  to  reduce  the  outstanding  public  debt.  This 
income  is  presumably  to  be  devoted,  first,  to  the  retirement 
of  the  one-year  three  per  cent  notes  just  described  and  then, 
if  there  is  a  balance  remaining,  to  the  pajnnent  of  any  other 
outstanding  obligation. 


CHAPTER  XIV 

The  Federal  Reserve  Notes 

Our  Inelastic  Supply  of  Money. — The  two  most  im- 
portant qualities  to  be  desired  iu  the  money  used  by  any 
country  are  safety  and  elasticity.  Gold  is  the  one  commod- 
ity acceptable  the  world  over  in  settlement  of  a  debt;  and 
so  long  as  any  other  form  of  money  we  use  can  be,  at  will, 
convertible  into  gold,  it  may  be  considered  safe.  In  our 
monetary  system  the  gold  certificates,  the  silver  dollars,  the 
silver  certificates,  and  the  subsidiary  silver  cause  no  diffi- 
culty in  this  particular.  Directly  or  indirectly  they  may 
be  exchanged  for  gold.  Since  1879  the  same  has  been  true 
of  the  United  States  notes  or  greenbacks,  while  at  no  time 
in  their  history  has  there  been  difficulty  with  the  national 
bank  notes.  Secured  as  they  are  by  a  deposit  of  United 
States  bonds  with  the  Treasurer  at  Washington,  there  has 
never  been  any  question  as  to  their  value. 

Elasticity  Difficult  to  Secure,  but  Important. — Elas- 
ticity is  not  so  easy  to  secure.  Even  England,  whose  bank- 
ing system  ranks  high,  has  almost  no  elasticity  in  her  money 
supply,  the  entire  structure  being  dependent  upon  elasticity 
of  credit.  The  elasticity  of  the  Bank  of  England  note,  if  it 
may  be  said  to  exist  at  all,  is  only  potential.  Elasticity  is 
needed  because  the  demand  for  money  is  irregular.  The 
situation  is  slightly  analogous  to  the  demand  for  freight  cars 
which  are  needed  in  large  numbers  at  some  seasons  of  the 
year  and  in  smaller  numbers  at  other  times.  The  result  is 
a  car  surplus  at  one  time  and  a  car  shortage  at  others.  If 
the  railroads  could,  at  will,  adjust  exactly  to  their  needs 
their  investment  in  rolling  stock,  they  would  save  them- 
selves much  embarrassment. 

Serious  as  an  inelasticity  in  the  supply  of  freight  cars 
may  be,  it  is  capable  of  less  disaster  than  an  inelastic  supply 
of  mone3^     Business  may   adjust  itself   to   the   available 

143 


144      OPERATION  OF  THE  NEW  BANK  ACT 

supply  of  freight  cars,  but  the  demand  for  money  is  absolute 
and  brooks  no  artificial  barriers.  Even  though  business 
may  become  adjusted  to  a  given  supply  of  money,  it  does  not 
long  remain  so.  The  demand  made  for  money  is  never  the 
same,  but  varies  from  day  to  day,  from  week  to  week,  from 
month  to  month,  and  from  year  to  year.  The  amount  of 
checks  drawn  against  deposits — our  so-called  deposit  cur- 
rency— automatically  adjusts  itself,  however,  to  these 
changes,  the  number  of  cheeks  drawn  always  being  equal  to 
the  demand  for  them. 

Inelasticity  Restrains  Business. — If  all  our  business 
could  be  done  by  check,  and  actual  money  were  used  only  in 
the  banks  and  in  the  Treasury  of  the  United  States  for  re- 
serve purposes,  inelasticity  in  the  supply  of  money  would 
be  much  less  important.  However,  our  demand  for  money 
as  a  medium  of  circulation  varies  constantly.  If  a  con- 
siderable amount  is  withdrawn  from  the  banks,  as  for  ex- 
ample in  the  fall  months,  the  power  of  the  banks  to  lend  is 
thereby  curtailed,  and  they  raise  interest  rates  and  reduce 
loans,  perhaps  making  it  impossible  for  many  men  with 
good  security  to  get  the  aid  they  need.  On  the  other  hand, 
when  money  is  not  needed  by  the  community,  it  is  deposited 
in  the  banks  which  are  tempted  to  lower  their  rates  and 
expand  loans  in  order  to  keep  it  busy. 

An  elastic  form  of  money  that  could  be  issued  in  just 
the  amount  needed  by  business  and  promptly  retired  when 
that  need  was  over  is  the  desirable  kind  to  have.  Our  gold, 
gold  certificates,  silver,  silver  certificates  and  United  States 
notes,  or  greenbacks,  are  practically  fixed  in  amount.  The 
issue  and  retirement  of  our  national  bank  notes  is  largely 
controlled  by  influences  having  no  relation  to  the  demands  of 
trade.  The  bond-secured  notes  of  the  reserve  banks  are  to 
be  similar  to  the  national  bank  notes,  and  their  supply,  plus 
that  of  the  national  bank  notes  that  remain  in  existence,  will 
probably  be  determined  by  the  same  influences  as  those 
affecting  the  volume  of  bank  notes  in  the  past.  If  we  are  to 
have  elasticitv  it  will  be  found  in  the  Federal  reserve  notes 


THE  FEDERAL  RESERVE  NOTES  145 

The    Differences    between    Notes    and    Deposits. — 

Within  limits  it  is  correct  to  say  that  a  bank  note  and  a 
bank  deposit  are  similar,  for  each  is  a  promise  of  the  bank 
to  pay  on  demand.  There  are,  however,  certain  important 
differences.  The  deposit  is  circulated  by  means  of  checks 
which  pass,  upon  endorsement,  between  individuals  known 
to  each  other,  and  are  not  legal  tender.  The  bank  note  does 
not  require  endorsement,  passes  freely  among  strangers,  and 
while  not  always  legal  tender,  is  usually,  as  a  matter  of 
practice,  accepted  in  settlement  of  a  debt. 

These  differences,  though  briefly  summarized,  are  of 
broad  significance.  Because  of  them,  safeguards  must  be 
thrown  about  note  issues  that  are  unnecessary  in  the  case 
of  deposits.  A  bank  may  be  allowed  to  create  deposit  liabili- 
ties with  small  restraint,  and  no  serious  harai  result.  This 
is  actually  the  practice  in  most  countries.  The  Bank  of  Eng- 
land, the  Bank  of  France,  the  Bank  of  Germany  and  the 
banks  of  Canada  are  not  required  by  law  to  maintain  any 
specified  cash  reserve  against  their  deposits.  The  only  re- 
straint imposed  is  the  judgment  of  their  manager's.  In  the 
United  States,  we  have  insisted  on  the  maintenance  of  a 
reserve  in  the  form  of  cash  and  deposits  with  other  banks, 
but  we  are  the  only  country  of  any  size  that  imposes  any 
such  legal  restraints. 

Limitations  on  Note  Issues  Are  Usual. — But  in  all 
the  leading  banking  systems  there  are  limitations  placed 
on  the  right  of  note  issue.  In  France  it  is  limited  to  the 
Bank  of  France.  In  England  and  Germany  also,  it  is,  with 
a  few  minor  exceptions,  limited  to  the  central  institutions. 
Another  frequent  form  of  limitation  is  in  the  amount  of  the 
issue.  The  banks  of  Canada  may  not  issue  beyond  an 
amount  equal  to  their  capital  stock,  except  during  the  fall 
and  early  winter ;  and  upon  the  extra  issues  at  that  time  a 
special  tax  must  be  paid.  Under  the  new  Canadian  Bank 
Act  of  1913,  provision  is  also  made  for  the  issue  of  extra 
notes  on  the  deposit  of  gold  with  certain  trustees,  a  device 
which  makes  these  special  notes  somewhat  like  our  gold 
certificates. 
10 


146       OPERATION  OF  THE  NEW  BANK  ACT 

The  Bank  of  England  notes,  with  the  exception  of 
£18,450,000  secured  by  government  obligations,  are  issued 
only  upon  the  deposit  of  gold.  They  are  for  the  most  part 
merely  gold  certificates.  The  Bank  of  Germany  must  pay 
a  five  per  cent  tax  on  issues  beyond  a  specified  minimum, 
known  as  the  "Contingent,"  and  must  always  keep  a  re- 
serve in  gold  of  thirty-three  and  one-third  per  cent  behind 
all  notes  issued.  The  Bank  of  France  is  not  required  to 
keep  any  special  reserve  or  security  behind  her  issues,  but 
may  not  exceed  in  amount  a  limit  set  from  time  to  time 
by  the  National  Assembly. 

These  restrictions  imposed  in  other  countries  are  not 
enumerated  as  meriting  our  imitation,  but  as  an  indication 
of  the  general  attitude  of  the  leading  countries  of  the 
world.  Restraints  like  those  in  England  would  probably 
give  us  no  elasticity.  Perhaps  none  of  the  devices  de- 
scribed would  exactly  fit  our  needs;  but  an  entire  absence 
of  limitations  on  note  issues  does  not  seem  good  judgment 
and  is  certainly  contrary  to  practice  elsewhere. 

The  bond-secured  notes  of  the  national  banks  and  of  the 
reserve  banks  are  safe,  but  are  made  so  at  the  sacrifice  of 
elasticity.  In  an  effort  to  provide  this  quality  Congress 
finally  agreed,  after  heated  discussion,  to  an  issue  of  Fed- 
eral reserve  notes  that  are  not  definitely  limited  in  amount, 
but  that  are  safeguarded  (1)  by  the  security  behind  each 
note,  and  (2)  by  the  requirement  that  a  certain  reserve 
must  always  be  held  against  the  notes  outstanding. 

Federal  Reserve  Notes. — Reserve  notes  are  to  be  obliga- 
tions of  the  United  States  and  are  receivable  by  all  national 
and  member  banks  and  reserve  banks,  and  for  all  taxes, 
customs  and  other  public  dues.  They  are  not  Jegal  tender 
for  other  purposes.  Individuals  can  not  be  compelled  to 
accept  them,  nor  may  the  national  banks  use  them  as  part 
of  their  legal  reserves.  State  banks  that  are  not  members 
may  use  them,  if  permitted  to  do  so  by  the  laws  of  their 
respective  States.  Since  they  now  use  the  national  bank 
notes  for  that  purpose,  the  new  Federal  reserve  notes  will 
doubtless  be  accepted  in  the  same  way.     State  banks  that 


THE  FEDERAL  RESERVE  NOTES  147 

are  members  of  the  system  must  comply  with  the  reserve 
requirements  that  are  prescribed  by  the  organization  com- 
mittee and  by  the  Federal  Reserve  Board,  supplementing 
the  stipulations  of  the  Act  itself.  While  the  board  may 
allow  State  member  banks  to  continue  using  national  bank 
notes  and  to  use  the  new  reserve  banks'  bond-secured  notes 
in  their  reserves,  it  does  not  seem  likely  that  they  will 
agree  to  the  use  of  the  Federal  reserve  notes  for  the  same 
purpose.  Such  a  policy  would  give  to  the  State  banks 
that  are  members  a  very  marked  advantage,  not  only  over 
the  non-member  State  banks,  which  may  discount  indirectly 
with  the  reserve  banks  only  to  a  limited  extent,  but  also 
over  the  national  banks,  which  will  be  unable  to  use  the 
Federal  reserve  notes  as  a  part  of  their  legal  reserves.  If 
this  supposition  be  correct,  we  are  safe  in  saying  that  the 
Federal  reserve  notes  may  not  be  used  as  reserves  by 
member  banks. 

These  notes  are  redeemable  in  gold  on  demand  at  the 
Treasury  Department  of  the  United  States  at  "Washington 
in  the  District  of  Columbia,  or  in  gold  or  lawful  money 
at  any  reserve  bank.  If  this  provision  is  adhered  to 
literally  they  will  not  be  redeemable  at  the  srubtreasuries, 
a  fact  which  may,  on  occasion,  add  to  the  difficulty  of 
securing  gold  for  them. 

Method  of  Issuing  the  Notes. — Any  reserve  bank  may 
make  application  to  the  local  Federal  reserve  agent  (that 
is,  the  chairman  of  its  own  board  of  directors)  for  such 
amounts  of  these  notes  as  it  may  require,  at  the  same  time 
offering,  as  collateral  security  therefor,  commercial  paper 
and  bills  rediscounted  by  it  for  member  banks.  This  se- 
curity must  be  at  least  equal  in  amount  to  the  notes  re- 
ceived. Some  of  these  securities  may  from  time  to  time 
be  withdrawn,  with  the  approval  of  the  Resers^e  Board, 
if  at  the  same  time  other  collateral  of  equal  amount  is 
substituted.  The  Reserve  Board  may  also  at  any  time  call 
for  additional  security.  As  the  notes  may  be  issued  for  no 
other  purpose  than  in  exchange  for  such  collateral,  and 
since  this  collateral  is  in  the  form  of  rediscounted  paper, 


H8       OPERATION  OF  THE  NEW  BANK  ACT 

it  may  be  said  that  the  notes  are  issued  only  through 
rediseounting. 

They  will  be  in  denominations  of  $5,  $10,  $20,  $50  and 
$100.  As  there  are  no  specifications  as  to  the  relative 
amounts  of  each,  it  is  probable  that  the  kind  needed  will 
always  be  furnished.  All  expenses  incident  to  their  issue 
and  retirement  must  be  met  by  the  reserve  bank  receiving 
them,  which  shall  also  pay  on  them  a  rate  of  interest  to  be 
determined  by  the  Reserve  Board.  Each  note  will  bear 
the  distinctive  number  of  the  reserve  bank  through  which 
it  is  issued.  In  anticipation  of  demand  for  them  a  quan- 
tity are  to  be  prepared  and  deposited  in  the  Treasury  or  in 
the  subtreasury  or  mint  of  the  United  States  nearest  the 
place  of  business  of  each  reserve  bank,  where  they  shall 
be  held  subject  to  the  order  of  the  Comptroller  of  the 
Currency. 

The  Reserve  behind  the  Notes. — Against  its  deposit 
liabilities,  every  reserve  bank  must  keep  a  reserve  of  not 
less  than  thirty-five  per  cent  in  gold  or  lawful  money. 
Against  the  notes,  however,  the  reserve  required  is  not  less 
than  forty  per  cent  in  gold  for  all  that  are  in  actual  circula- 
tion and  not  offset  by  gold  or  lawful  money  deposited  with 
the  reserve  agent.  This  does  not  mean  that  each  bank  will 
always  maintain  merely  the  required  minimum.  "With  no 
legal  requirement  at  all  the  Bank  of  England  kept  an 
average  of  47.4  per  cent  against  its  demand  liabilities 
from  1901  to  1910  inclusive.  During  the  same  period  the 
Bank  of  France  kept  an  average  of  84.5  per  cent  and  the 
Bank  of  Germany  72.5  per  cent  in  cash  against  their  note 
issues  alone.  We  may  expect  that  in  view  of  their  heavy 
responsibilities,  some  if  not  all  of  the  reserve  banks  will  con- 
stantly keep  more  than  the  required  minimum. 

One  of  the  serious  difficulties  with  a  system  in  which 
the  law  specifies  the  reserves  that  must  be  held,  is  the  fact 
that  the  legal  limitation  in  itself  implies  that  the  reserves 
are  not  to  be  used.  When  the  limit  is  reached,  the  banks 
are  legally  debarred  from  lending.  If  they  continue  to 
make  loans,  they  break  the  law ;  while  if  they  refuse,  they 


THE  FEDERAL  RESERVE  NOTES  149 

seriously  hamper  business.  Tlie  Act  endeavors  to  avoid 
this  difficulty  by  authorizing  the  Federal  Reserve  Board 
to  suspend  any  and  every  reserve  requirement  in  the  Act 
for  a  period  not  exceeding  thirty  days,  and  from  time  to 
time  to  renew  such  suspension  for  periods  not  exceeding 
fifteen  days. 

Checks  against  Excessive  Issues. — This  applies  to  the 
reserves  of  the  reserve  banks  and  also  to  those  of  all  mem- 
ber banks,  both  national  and  State,  except  where  it  would 
involve  a  violation  of  the  laws  of  the  States  in  which  State 
banks  and  trust  companies  belonging  to  the  system  are 
located.  We  are  concerned  in  this  chapter,  however,  only 
with  the  reserves  against  the  notes.  The  forty  per  cent 
requirement  may  be  suspended  by  the  Reserve  Board,  but 
another  check  is  introduced  in  the  requirement  that  if  the 
gold  reserves  against  the  note  issues  shall  fall  below  forty 
per  cent,  a  graduated  tax  shall  be  paid  by  the  reserve 
bank.  This  tax  shall  be  at  the  rate  of  not  more  than  one 
per  cent  per  annum  upon  the  deficiency,  unless  the  re- 
serve falls  below  thirty-two  and  one-half  per  cent.  If  it 
goes  below  that  point,  the  tax  shall  be  increased  by  one 
and  one-half  per  cent  per  annum  upon  each  two  and  one- 
half  per  cent,  or  fraction  thereof,  that  such  reserve  falls 
below  thirty-two  and  one-half  per  cent.  This  tax  is  to 
be  paid  by  the  reserve  bank,  but  it  is  required  to  add  an 
equivalent  amount  to  the  rates  of  interest  and  discount 
fixed  for  it  by  the  Federal  Reserve  Board. 

The  facts  recited  have  to  do  solely  with  the  legal  re- 
quirements as  to  the  form  and  manner  of  the  note  issue, 
but  do  not  give  a  picture  of  the  actual  process.  This  will 
be  described  in  the  next  chapter  and  will  be  followed  by  a 
discussion  of  the  possibilities  of  inflation  through  the  issue 
of  notes. 


CHAPTER  XV 

Issuing  and  Retiring  the  Federal  Reserve  Notes 

Reserve  Banks  Will  not  Retain  National  Bank 
Notes. — Probably  national  bank  notes  will  not  be  held  in 
the  vaults  of  the  reserve  banks  to  any  considerable  extent. 
The  reserves  of  these  banks  must  be  in  gold  or  other  lawful 
money,  and  consequently  they  will  send  all  national  bank 
notes  received  by  them  to  the  redemption  agency  at  Wash- 
ington in  order  to  secure  lawful  money,  which  may  be  used 
in  their  reserves.  They  may,  on  occasion  and  perhaps  al- 
ways, present  to  an  individual  national  bank  its  own  notes. 
Especially  would  this  occur  if  such  a  bank's  account  with 
the  reserve  bank  were  growing  large  and  needed  to  be  off- 
set. In  such  a  situation  all  notes  of  that  bank  received  by 
the  reserve  bank  would  be  charged  against  its  account  and 
the  notes  themselves  returned.  In  the  future  national  bank 
notes  will  by  these  two  methods  be  presented  for  redemp- 
tion much  more  promptly  than  in  the  past.  It  has  been 
customary  for  these  notes  to  be  sent  to  Washington  chiefly 
through  New  York  and  a  very  few  other  large  cities.  Each 
bank  receiving  national  bank  notes  that  could  not  be 
counted  in  reserves  has  deposited  them  for  credit  with  a 
reserve  agent  who  has,  when  possible,  passed  them  on.  When 
they  could  be  redeposited  no  longer,  the  bank  holding  them 
(usually  a  bank  in  a  central  reserve  city),  has  sent  them  to 
Washington. 

Redemption  Process  Will  Be  Hastened. — This  process 
has  taken  considerable  time.  While  individual  notes  may 
have  come  back  to  the  bank  of  issue  several  times  during  a 
year,  the  total  issue  of  any  bank  has  required  more  than 
a  year  to  return.  Hereafter  this  may  be  somewhat  has- 
tened. A  Federal  reserve  bank  may  deposit  cash  with 
another  reserve  bank,  but  only  for  exchange  purposes. 
National  bank  notes  may  be  included  in  such  deposits,  but 
150 


ISSUING  AND  RETIRING  FEDERAL  NOTES  151 

the  limitation  to  exchange  purposes  indicates  that  they  will 
not  be  so  used  in  very  large  volume.  The  natural  way  to 
dispose  of  them  will  be  to  send  them  back  to  the  bank  that 
issued  them  or  to  the  redemption  agency  at  Washington, 
which  will  return  them.  If  this  greater  rapidity  of  the 
redemption  process  occurs,  the  national  banks  may  be  in- 
clined to  retire  their  circulation.  Unless  the  notes  can  be 
kept  out,  the  profits  thereon  will  be  still  further  reduced 
and  the  privilege  of  note  issue  becomes  less  valuable. 

Form  of  Payment  by  the  Reserve  Banks. — The  next 
form  of  money  which  may  be  offered  by  a  reserve  bank  to 
its  member  banks  is  the  bond-secured  notes  of  the  reserve 
bank  itself.  These  notes,  it  will  be  remembered,  are  secured, 
like  the  present  national  bank  notes,  by  United  States  bonds 
deposited  with  the  Treasurer  at  Washington.  Since  the 
funds  of  the  reserve  banks  may  be  in  part  invested  in  these 
bonds,  which  will  yield  only  two  per  cent  interest,  they  will 
wish  to  keep  them  out  as  much  of  the  time  as  possible,  and 
will  offer  them  whenever  they  can.  If  there  is  a  demand 
for  still  more  cash,  or  if  the  reserve  bank  does  not  wish  to 
give  either  of  the  kinds  of  money  thus  far  named,  the  next 
kind  to  be  handed  out  will  be  Federal  reserve  notes.  As 
already  explained,  these  notas  may  not  be  issued  except  in 
return  for  rediscounted  paper  of  the  sort  acceptable  under 
the  terms  of  the  Act.  Inasmuch  as  the  issue  of  these  notes 
will  not  reduce  the  reserves  of  the  reserve  bank,  they  will 
usually  be  issued  in  preference  to  gold  or  other  lawful 
money.  Application  for  the  notes  must  be  made  to  the 
Federal  reserve  agent,  and  the  required  collateral  must  be 
deposited  with  him.  A  rate  of  interest,  established  by  the 
Federal  Reserve  Board,  will  be  charged  the  reserve  bank 
for  all  the  notes  received  by  it. 

Purposes  for  Which  Member  Banks  Need  Cash. — A 
member  bank  may  need  cash  for  one  or  both  of  two  pur- 
poses. The  cash  may  be  wanted  for  counter  money,  to  be 
handed  out  as  there  is  call  for  it  by  the  customers  of  the 
bank;  or  the  member  bank  may  want  cash  because  its  re- 
serves are  low  and  need  to  be  replenished.    For  the  former 


15'2       OPERATION  OF  THE  NEW  BANK  ACT 

purpose  the  Federal  reserve  notes,  as  well  as  national  bank 
notes  and  reserve  bank  notes,  may  be  used.  They  will 
doubtless  be  accepted  as  readily  as  any  other  form  of 
money.  No  one  of  them,  however,  is  available  for  use  in 
the  reserves  of  the  member  banks,  and  if  the  demand  for 
cash  is  prompted  by  this  need,  none  of  these  forms  will  be 
satisfactory.  The  problem  could  have  been  solved  by  speci- 
fying in  the  Act  that  these  notes  could  be  used  as  reserves 
by  member  banks,  at  the  discretion  of  the  Federal  Reserve 
Board.  In  fact,  this  form  of  solution  was  discussed  from 
time  to  time,  but  as  finally  passed  the  Act  does  not  make 
such  provision.  The  member  bank  may,  however,  take  the 
Federal  reserve  notes  as  soon  as  they  have  been  issued  and 
present  them  at  the  counter  of  the  reserve  bank  from  which 
it  received  them  and  ask  for  lawful  money.  If  it  should 
hesitate  to  present  them  so  promptly,  it  could  exchange 
them  for  lawful  money  at  another  bank,  perhaps  a  non- 
member  institution,  and  that  bank  could  either  hold  them 
in  its  vaults  or  present  them  for  lawful  money  either  at 
one  of  the  reserve  banks  or  at  the  redemption  agency  at 
Washington.  There  is  thus  a  way  by  which  the  member 
bank  may  secure  lawful  money  whether  the  reserve  bank 
wishes  to  deliver  it  or  not. 

The  Wisdom  of  the  Plan  Doubtful. — The  wisdom  of 
such  an  arrangement  is  by  no  means  certain.  When  it  was 
suggested  that  such  notes  should  be  used  by  the  member 
banks  as  a  part  of  their  reserves,  there  was  expressed  great 
fear  of  inflation.  Many  felt  that  there  might  be  an  irresist- 
ible demand  by  the  banks  to  rediscount  their  paper  merely 
in  order  to  secure  notes  that  could  be  used  as  a  basis  for 
new  loans,  the  second  instalment  of  commercial  paper  thus 
secured  to  be  in  turn  rediscounted  to  secure  still  more  notes. 
Such  an  outcome,  it  was  urged,  would  merely  mean  an  over- 
extension of  credit  and  enormous  inflation.  The  proposal 
that  the  Federal  Reserve  Board  might  be  allowed  to  use 
their  discretion  in  the  matter  was  also  voted  dowTi. 

Was  the  final  decision  an  improvement  ?  As  with  most 
other  questions  that  involve  the  future,  positive  conclu- 


ISSUING  AND  RETIRING  FEDERAL  NOTES  153 

sions  are  impossible,  but  a  careful  examination  of  the  prob- 
abilities of  the  case  makes  one  doubtful.  If  a  particular 
bank  needs  help,  any  form  of  money  is  acceptable  to  it, 
provided  it  may  be  offered  to  creditors  in  settlement  of  obli- 
gations. In  such  cases  the  Federal  reserve  notes  will  meet 
the  need.  Any  bank  may  pay  them  out  over  its  counter  to 
individual  customers  or  even  compel  their  acceptance  by 
other  banks  in  the  settlement  of  unfavorable  clearing  house 
balances,  since  the  Act  specifies  that  they  "shall  be  receiv- 
able by  all  national  and  member  banks  and  Federal  reserve 
banks."  They  must  also  be  taken  by  the  government  and 
doubtless  will  be  acceptable  to  non-member  banks. 

But  such  occasions  are  not  the  only  ones  upon  which 
Federal  reserve  notes  will  be  needed.  When  business  un- 
certainty is  general,  when  there  is  widespread  unrest  and 
not  merely  distrust  of  a  particular  bank,  the  need  is  not  so 
much  for  cash  as  for  increased  power  to  lend.  The  same 
need  is  the  dominant  one  during  any  normal  expansion  of 
business.  Unless  loans  are  granted  at  such  times,  business 
becomes  congested,  transportation  is  checked,  obligations 
can  not  be  met,  and  failures  follow.  In  the  past  our  national 
banks  have  often  had  to  choose  between  breaking  the  law 
and  paralyzing  business.  It  is  to  their  credit  and  to  the 
credit  of  the  Comptroller  of  the  Currency  that  they  have 
often  broken  the  law  in  order  to  prevent  commercial  dis- 
aster. 

Federal  Reserve  Notes  not  Legal  for  Reserves. — The 
use  of  Federal  reserve  notes  as  reserves  by  monibor  banks 
is  not  authorized  by  the  Act.  Even  with  a  normal  expan- 
sion of  business,  rediscounting  by  a  member  will  not  furaish 
it  with  an  addition  to  its  reserves  and  facilitate  loans.  The 
needed  help  must  be  secured  indirectly,  and  three  methods 
are  possible.  First,  the  Federal  reserve  notes  may  be  handed 
out  to  customers,  all  lawful  money  in  the  possession  of  thn 
l)ank  being  retained.  Second,  the  reserve  notes  may  be  paid 
out  to  a  non-member  institution  which  is  allowed  by  the 
laws  of  its  State  to  count  them  as  reserves.  Third,  the 
reserve  notes  may  be  presented  for  redemption  in  lawful 


154       OPERATION  OF  THE  NEW  BANK  ACT 

money  at  any  one  of  the  resei^ve  banks,  or  for  redemption 
in  gold  at  the  Treasury  Department  in  Washington. 

If  the  third  of  these  alternatives  is  adopted  by  the  mem- 
ber bank,  prompt  redemption  of  the  notes  is  secured,  but 
perhaps  at  the  expense  of  the  lawful  money  holdings  of 
the  reserve  banks.  If  the  notes  are  paid  to  or  exchanged 
for  lawful  money  with  a  non-member  bank  they  may  go  into 
its  reserves  and  are  made  the  basis  of  loans.  If  they  are 
paid  out  over  the  counter  to  the  customers  of  the  bank,  they 
probably  will  not  remain  indefinitely  in  circulation.  It 
may  be  presumed  that  a  few,  but  only  a  very  few,  will  be 
hoarded.  Since  the  denominations  range  from  five  dollars 
to  one  hundred  dollars,  they  will  certainly  not  stay  in 
general  circulation  as  readily  as  the  one  dollar  and  two 
dollar  silver  certificates,  but  will  drift  into  the  tills  of  the 
stores  and  other  business  concerns,  to  be  redeposited  by 
them  in  the  banks.  This  will  be  especially  true  of  the  higher 
denominations. 

Will  Be  Retired  Rapidly. — Our  experience  in  this  with 
the  national  bank  notes  which  are  issued  in  denominations 
of  five  dollars  and  up,  is  interesting.  During  the  year  end- 
ing June  30,  1913,  national  bank  notes  to  the  amount  of 
$675,889,000  were  sent  to  the  redemption  agency  at  Wash- 
ington. This  is  90.01  per  cent  of  the  average  amount  of 
these  notes  outstanding  during  the  year.  It  is  fair  to 
assume  that  the  Federal  reserve  notes  will  be  redeemed 
with  greater  rapidity  than  has  heretofore  been  the  case 
with  the  national  bank  notes. 

The  Process  of  Redemption  Described. — This  redemp- 
tion process  will  be  hastened  by  the  fact  that  the  Federal 
reserve  notes  issued  through  one  reserve  bank  that  are 
received  by  another  reserve  bank  must  be  promptly  returned 
for  credit  or  redemption  to  the  bank  through  which  they 
were  originally  issued.  No  reserve  bank  shall  pay  out  notes 
issued  by  another  under  penalty  of  a  tax  of  ten  per  cent 
upon  the  face  value  of  the  notes  so  paid  out.  The  situation 
will  be  similar  to  the  one  we  find  to-day  in  the  clearing  of 
checks.     Everj^  bank  promptly  forwards  to  the  clearing 


ISSUING  AND  RETIRING  FEDERAL  NOTES  155 

house,  or  sends  for  collection  through  the  mail,  all  items 
it  holds  against  other  institutions,  knowing  that  checks 
against  itself  will  be  coming  back  promptly  and  also  that 
the  law  requires  prompt  collection  to  avoid  loss  on  worth- 
less items.  Any  reserve  bank  receiving  the  notes  of  another 
reserve  bank  will  redeem  them  at  once. 

Provision  is  made  for  the  redemption  of  the  Federal 
reserve  notes  at  any  Federal  reserve  bank  in  gold  or  lawful 
money,  and  in  gold  at  the  Treasury  Department  in  Wash- 
ington. No  reference  is  made  to  redemption  at  the  sub- 
treasuries.  This  will  doubtless  mean  that  a  considerable 
number  of  notes  will  concentrate  for  redemption  purposes  in 
Washington.  Each  reserve  bank  is  required  to  maintain  in 
the  Treasury  of  the  United  States  at  Washington  a  deposit 
of  gold  which  is  sufficient,  in  the  judgment  of  the  Secretary 
of  the  Treasury,  for  the  redemption  of  the  Federal  reserve 
notes  issued  to  that  bank,  but  which  shall  in  no  case  be  less 
than  five  per  cent  of  that  issue.  This  deposit  of  gold  may 
be  counted  as  a  part  of  the  forty  per  cent  reserve  required 
behind  the  notes.  When  notes  are  presented  for  redemption 
at  Washington,  payment  is  to  be  made  out  of  this  redemption 
fund  and  the  notes  returned  to  the  reserve  bank  through 
which  they  were  originally  issued.  That  bank  shall  then 
be  required  to  reimburse  the  redemption  fund  in  lawful 
money.  If  the  redemption  at  the  Treasury'  Department 
has  been  made  in  gold  or  gold  certificates,  then  the  reim- 
bursement shall  be  in  gold  or  gold  certificates  to  such  an 
extent  as  may  be  deemed  necessary  by  the  Secretary  of  the 
Treasury.  If  the  Treasury  Department  receives  Federal 
reserve  notes  otherwise  than  for  redemption, — for  example, 
in  payment  of  taxes, — the  notes  so  received  may  be  ex- 
changed for  gold  in  the  redemption  fund  and  returned  to 
the  reserve  bank,  or  they  may  be  returned,  without  being 
diverted  to  the  redemption  fund,  for  credit  to  the  deposit 
of  the  United  States. 

Contraction  Will  Be  Prompt. — There  is  thus  a  method 
for  the  prompt  issue  of  the  Federal  reserve  notes  to  any 
amount  that  may  be  required  liy  any  member  bank  that  is 


15G       OPERATION  OF  THE  NEW  BANK  ACT 

willing  to  offer  as  security  for  them  the  paper  acceptable 
for  rediscount.  There  is  also  provision  for  the  prompt 
retirement  of  these  notes  as  rapidly  as  they  shall  reach 
the  vaults  of  the  various  reserve  banks  or  the  Treasury 
Department.  There  are  several  other  reasons  for  believing 
that  contraction  will  be  prompt.  These  notes  are  issued 
as  an  advance  to  member  banks  upon  collateral  security. 
When  the  discounted  paper,  which  is  furnished  as  col- 
lateral, falls  due,  it  must  be  collected,  and  the  reserve  bank 
will  presumably  deliver  it  to  the  member  bank  for  collec- 
tion rather  than  attempt  to  collect  it  direct.  Since  the 
member  has  endorsed  the  paper,  it  will  be  liable  for  pay- 
ment, and  the  bank  will,  in  so  far  as  possible,  deliver  national 
bank  notes,  reserve  bank  notes  and  Federal  reserve  notes  in 
settlement  of  the  obligation,  unless  of  course  it  wishes  to 
substitute  other  collateral  and  such  substitution  is  accept- 
able to  the  reserve  bank.  It  will  also  be  necessan^  for  it 
to  maintain  its  required  reserves  with  the  reserve  bank  of 
its  district,  and  perhaps  also  a  considerable  balance  in  ex- 
cess of  the  reserve  for  exchange  purposes.  There  will  be 
an  inducement  to  turn  in  promptly  the  forms  of  money  just 
referred  to,  rather  than  gold  and  other  lawful  money  which 
may  be  held  in  reserv^e. 

The  New  Note  Issue  Elastic. — This  description  of  the 
processes  of  issue  and  of  retirement  answers,  to  a  consider- 
able extent,  the  question  of  the  elasticity  of  the  new  form  of 
money.  The  notes  will  be  put  out  only  when  business  calls 
for  cash.  They  will  be  retired  just  as  promptly  as  the  de- 
mand for  this  increased  amount  of  money  is  passed.  The 
general  public  will  not  distinguish  between  the  different 
kinds  of  money  and  doubtless  will  retain  some  of  the  Fed- 
eral reserve  notes  in  their  pockets  indefinitely.  Within  a 
short  time,  however,  most  of  them  will  drift  into  the  hands 
of  the  banks,  which  will  dispose  of  them  in  the  manner  de- 
scribed. Provision  thus  seems  to  have  been  made  for  elas- 
ticity. Even  their  use  by  non-member  State  banks  will 
not  destroy  this  arrangement.  Upon  the  maturity  of  the 
collateral  security  held  by  the  Federal  reserve  agent,  the 


ISSUING  AND  RETIRING  FEDERAL  NOTES  157 

member  bank  must  make  payment.  If  reserve  notes  are 
not  at  hand,  other  forms  of  money  must  be  used  or  a  new 
supply  of  paper  rediseounted.  In  no  ease  is  the  reserve 
bank  or  the  Federal  reserve  agent  left  without  adequate 
protection.  If  the  commercial  paper  is  withdrawn!,  resei've 
notes  or  other  forms  of  money  must  be  paid  for  it. 

They  Are  also  Safe. — This  raises  the  whole  question 
of  their  safety.  The  security  behind  the  national  bank 
notes  and  reserve  bank  notes  is  the  United  States  bonds,  but 
many  feel  that  the  security  behind  the  Federal  reserve  notes 
is  not  adequate.  A  simimary  of  the  nature  and  extent  of 
that  security  is  necessary  to  a  fair  judgment.  Probably  no 
better  statement  on  this  point  has  been  made  than  the  one 
given  by  Senator  Owen,  Chairman  of  the  Committee  on 
Banking  and  Currency  of  the  United  States  Senate,  during 
the  hearings  on  the  bill.  During  the  questioning  of  Mr. 
Untermyer  on  September  22,  1913,  Senator  Owen  inter- 
posed the  following  statement  which  can  not  well  be  im- 
proved upon: 

"  The  primaiy  security  against  these  notes  consists  of 
the  note  of  the  individual  which  is  discounted,  and  which, 
under  the  terms  of  this  bill,  has  a  short  maturity.  Under 
the  law  of  probabilities,  the  danger  of  a  man  who  is  regarded 
as  good  by  a  bank  and  to  whom  the  money  is  loaned  failing 
within  60  or  90  days  would  probably  be  about  one  in 
25,000. 

"And  such  a  note,  before  it  becomes  a  security  under  the 
system  for  the  issuance  of  these  Treasury  notes,  must  also 
be  endorsed  by  the  member  bank.  And  under  the  law  of 
probability,  the  probability  of  a  member  in  good  standing, 
examined  by  the  examiners,  and  reported  as  sound,  failing 
within  the  period  of  60  days,  or  90  days — the  life  of  the 
contemplated  transaction — is  probably  one  in  100.000.  And 
the  measure  of  probability  of  the  failure  of  the  individual 
maker  of  the  note  and  of  the  bank  which  indorses  that  note, 
failing  within  tlio  limitod  number  of  days,  would  be  meas- 
ured by  25,000  multiplied  by  100,000. 

"If,  however,  such  a  contingency  should  arise,  then  the 


158       OPERATION  OF  THE  NEW  BANK  ACT 

note  has  the  further  security  of  the  double  liability  of  the 
stockholders  of  the  member  bank  indorsing  that  note. 

"If,  however,  those  resources  should  fail,  the  government 
in  that  contingency  would,  against  such  a  loss  of  security, 
have  the  stock  of  that  particular  member  bank  that  failed 
in  this  reserve  bank. 

"In  addition  to  that,  however,  it  would  also  have  the 
security  of  the  reserve  deposit  of  this  member  bank  with 
the  reserve  bank.  If,  however,  those  resources  should  all 
fail,  the  government  would  have  a  further  safeguard  as 
to  these  particular  notes,  in  the  thirty-three  and  one-third 
per  cent  gold  reserve  required  against  the  notes. 

"And  in  addition  to  that  it  would  have  a  first  lien  upon 
the  assets  of  this  bank,  which  you  have  in  this  particular 
case  of  exemplification  named,  amounting  to  $40,000,000. 

"And  in  addition  to  that  you  have  the  double  liability  of 
the  member  bank  for  the  amount,  equal  to  a  like  sum  with 
their  capital. 

' '  There  never  has  been,  in  the  history  of  the  world,  a  note 
secured  by  such  a  vohune  of  security." 

The  accuracy  of  Senator  Owen's  conclusions  based  upon 
the  "law  of  probabilities"  may  be  questioned.  Dun's  Re- 
view shows  the  percentage  of  business  failures  in  the  twelve 
months  of  1911  to  have  been  eighty-eight  one-hundredths 
of  one  per  cent,  which  is  about  one  failure  out  of  every  one 
hundred  and  fourteen  business  establishments.  The  report 
of  the  Comptroller  of  the  Currency  shows  three  national 
bank  failures  in  1911  out  of  a  total  of  7,328  banks  or  one 
in  2,442  banks.  The  statistics  in  Dun's  Review  are  not  a 
complete  picture,  since  a  certain  number  of  small  business 
establishments  are  not  included. 

Upon  the  basis  of  the  above  figures,  the  chances  of  the 
average  business  concern  failing  within  sixty  days  is  about 
one  in  684,  and  the  chances  for  a  national  bank  failing  in 
this  period  is  one  in  14,652.  The  chances  of  a  business  con- 
cern and  the  bank  through  which  its  paper  was  redis- 
counted,  failing  within  this  time,  would  be  these  sums  mul- 
tiplied, or  one  in  10,021,968.    Wliile  this  result  is  somewhat 


ISSUING  AND  RETIRING  FEDERAL  NOTES  159 

below  that  indicated  in  the  statement  of  Senator  Owen, 
nevertheless  it  strikingly  illustrates  what  a  small  risk 
a  reserve  bank  takes  in  buying  the  paper  of  a  business 
establishment  endorsed  by  the  selling  member  bank. 

Not  Similar  to  the  Greenbacks. — The  notes  are  promises 
of  the  government,  but  the  security  that  is  placed  behind 
them  puts  them  in  a  class  very  different  from  the  gi'een- 
backs.  A  point  not  sufficiently  emphasized  in  Senator 
Owen's  statement  is  the  further  fact  that  the  commercial 
paper  protecting  these  notes  may  not  be  of  a  maturity  of 
more  than  ninety  days,  except  a  limited  amount  of  paper 
drawn  or  issued  for  agricultural  purposes  or  based  on  live 
stock,  which  may  have  a  maturity  of  not  more  than  six 
months.  The  fact  that  this  paper  quickly  matures  and 
must  be  paid  means  that  the  notes  will  be  retired  or  lawful 
money  be  delivered  to  the  reserve  bank  in  settlement.  In 
either  case  the  reserve  bank  has  been  furnished  with  assets 
sufficient  to  meet  the  outstanding  notes. 


CHAPTER  XVI 

Possibility  of  Inflation 

What  is  Inflation? — There  are  few  questions,  even  in 
the  field  of  money  and  banking,  upon  which  there  is  a 
more  vigorous  difference  of  opinion  than  upon  inflation. 
Each  disputant  has  a  different  idea  of  the  meaning  of  the 
word  and  usually  does  not  employ  the  same  meaning  twice 
in  succession.  In  fact  it  would  not  be  far  wrong  to  say 
that  most  people  use  the  word  with  no  clear  idea  at  all. 

This  is  not  surprising,  as  an  exact  definition  of  the 
term  is  extremely  difficult.  By  it  is  usually  meant  either 
(1)  an  increase  in  the  volume  of  money  that  will  drive  gold 
from  the  country  and  leave  us  with  an  inferior  money  in  its 
place,  or  (2)  an  unwise  increase  in  bank  loans  due  to  an 
increased  output  of  money  or  to  some  other  cause.  It  has 
been  urged  that  under  the  new  Act  both  of  these  conditions 
will  result.  It  is  pointed  out  that  the  issue  of  reserve  notes 
to  an  unlimited  amount — for  no  limit  is  fixed  by  the  Act 
itself — will  result  in  the  appearance  of  a  very  large  volume 
of  money  that  will  go  into  the  vaults  of  the  banks  and  the 
pockets  of  the  people,  taking  the  place  of  the  various  forms 
of  lawful  money  now  used ;  that  this  increase  in  the  supply 
of  money  will  result  in  interest  rates  in  the  United  States 
so  much  lower  than  those  abroad  that  foreign  bankers  will 
borrow  from  us  and  our  bankers  will  be  tempted  to  lend 
elsewhere  than  in  our  own  country;  and  that,  as  a  conse- 
quence, the  demand  for  exchange  will  be  quickly  raised  to 
the  point  where  the  exportation  of  gold  from  the  country 
will  be  profitable.  This  withdrawal  of  gold,  it  is  said, 
will  continue  until  an  equilibrium  has  been  reached.  In 
the  meantime  the  larger  supply  of  cash  in  the  vaults  of  the 
banks  will  encourage  bankers  to  lend  more  freely  than 
before,  and  will  perhaps  tempt  them  to  accept  inadequate 
security,  thus  giving  encouragement  to  enterprises  which 
should  not  be  undertaken. 
100 


POSSIBILITY  OF  INFLATION  161 

Why  It  Has  Been  Feared. — Cue  of  the  most  effective 
presentations  of  this  view  was  made  by  Senator  Elihu  Root 
in  his  speech  before  the  United  States  Senate  on  December 
13,  1913.  He  laid  stress  upon  the  spirit  of  optimism  which 
is  so  strong  among  all  mankind,  and  which,  in  the  absence 
of  restraint,  always  leads  men  to  take  a  rosy  view  of  the 
future.  As  a  result  the  earning  power  of  properties  is 
overestimated,  the  success  of  new  enterprises  seems  abso- 
lutely sure,  failure  seems  impossible,  and,  therefore,  values 
are  increased  until  the  breaking  point  is  reached.  This 
undue  rise  in  values  is  in  itself  injurious  and  encourages 
speculation  and  gambling,  while  the  reaction  which  always 
comes  sooner  or  later  brings  with  it  widespread  disaster. 

Senator  Root  pointed  out  that  the  Federal  reserve  notes 
provided  for  in  the  bill  are  to  be  promises  of  the  United 
States  government.  There  is  already  outstanding  in  the 
United  States  a  tremendous  volume  of  different  forms  of 
money,  including  gold  coin,  standard  silver  dollars,  subsid- 
iary silver,  gold  certificates,  silver  certificates,  Treasury 
notes  of  1890,  United  States  notes  or  greenbacks,  and  na- 
tional bank  notes,  Avhich  altogether  amounted  on  November 
1,  1913,  to  $3,417,109,678.  The  gold  certificates  are  pro- 
tected by  gold  held  in  trust  against  them,  and  the  silver 
certificates  are  protected  by  silver  dollars  whose  bullion 
value  is  now  about  one-half  of  their  face  value.  Allowing 
for  these  facts,  Senator  Root  found  a  total  of  $824,064,118 
of  government  obligations,  behind  which  the  government 
holds  $150,000,000  in  gold  reserve  and  the  silver  dollars 
above  referred  to,  which  would  give  a  total  metallic  value 
of  about  $391,331,000.  At  the  time  Senator  Root  was 
speaking,  the  bill  provided  a  reserve  in  gold  or  lawful 
money  of  thirty-five  per  cent  behind  the  deposits  of  the 
reserve  banks  and  the  Federal  reserve  notes.  As  finally 
passed,  the  reserve  against  the  notes  alone  was  raised  to 
forty  per  cent,  so  that  Senator  Root's  estiinnlcs  need  to  be 
slightly  modified.  He  declared  that  the  cash  assets  of  the 
new  reserve  banks  would  be  $636,000,000.  If  this  amount 
is  correct  and  consisted  of  gold,  it  would  make  possible  an 
enormous  note  issue.  This  great  increase  in  government 
11 


162      OPERATION  OF  THE  NEW  BANK  ACT 

obligations  was  viewed  with  di-ead  by  Senator  Root  and 
many  others,  and  it  was  doubtless  because  of  their  protests 
that  several  important  changes  were  introduced  in  the 
wording  of  the  Act. 

Federal  Reserve  Notes  are  Promises  of  the  Govern- 
ment.— If  inflation  is  possible  under  the  new  law,  it  will  be 
accomplished  through  the  unlimited  increase  of  paper  bear- 
ing the  government 's  promise  to  pay.  This  paper  is  referred 
to  as  fiat  money  by  those  who  fear  its  harmful  effects. 
It  might  be  a  danger  to  the  community,  if  it  were  held  in 
the  reserves  of  the  banks,  encouraging  careless  lending  and 
displacing  gold  or  other  lawful  money  in  the  pockets  of  the 
people.  This  condition  might  result  in  the  exportation  of 
gold  as  previously  explained,  A  further  reason  for  fearing 
inflation  is  found  in  the  lower  reserve  requirements  of  the 
various  banks.  It  is  held  that  the  money  set  free  because  of 
the  reduction  of  the  required  reserve  of  the  country  banks 
from  fifteen  per  cent  to  twelve  per  cent,  of  the  reserve  city 
banks  from  twenty-five  per  cent  to  fifteen  per  cent,  and  of 
the  central  reserve  city  banks  from  twenty-five  per  cent  to 
eighteen  per  cent,  would  give  to  the  community  an  increased 
supply  of  cash  that  would  tempt  extravagance  and  careless- 
ness. 

Senator  Root  and  others  declared  that  the  checks  pro- 
vided against  this  inflation  w^ere  insufficient,  and  would  be 
entirely  ineffective.  Thus,  for  example,  the  bill  provides 
no  limit  to  the  amount  of  notes  to  be  issued,  nor  does  it  pro- 
vide any  surtax  on  issues  beyond  a  given  point.  The  limit 
set  by  the  National  Assembly  on  the  note  issues  of  the  Bank 
of  France  is  6,800,000,000  francs.  Issues  beyond  a  given 
limit  by  the  Bank  of  Germany  are  taxed  at  the  rate  of  five 
per  cent  per  annum,  and  all  note  issues  of  the  Canadian 
banks  in  excess  of  their  capital  are  subject  to  tax,  unless 
fully  secured  by  a  deposit  of  gold.  Our  law,  it  is  urged, 
should  impose  a  similar  restraint.  The  restriction  that  no 
bank  shall  lend  to  any  one  person,  company,  firm  or  cor- 
poration in  excess  of  ten  per  cent  of  its  capital  and  surplus 
is  held  to  be  entirely  unsatisfactory,  because  it  is  followed 
by  the  stipulation,  "but  this  i-estriction  shall  not  apply  to 


POSSIBILITY  OF  INFLATION  163 

the  discount  of  bills  of  exchange  drawn  in  good  faith  against 
actually  existing  values."  It  is  urged  that  this  ([ualification 
renders  of  no  effect  the  preceding  limitation.  In  the  words 
of  Senator  Root,  "there  is  no  new  enterprise  conceivable  in 
this  country ;  no  one  of  us  has  known,  in  the  past  decade,  a 
new  enterprise  which  could  not  be  financed  by  bills  and  notes 
coming  witliiii  tlic  di'sr-ription  of  tlie  bill  I  have  read." 

Checks  against  Infl=ition. — In  reply  there  are  a  number 
of  arguments  to  be  presented.  Under  the  terms  of  the  bill 
only  commercial  paper  is  acceptable  for  rediscount.  This 
commercial  paper  is  defined  in  the  Act  as  "notes,  drafts 
and  bills  of  exchange  issued  or  drawn  for  agricultural,  in- 
dustrial or  commercial  purposes  or  the  proceeds  of  which 
have  been  used  or  are  to  be  used  for  such  purposes."  The 
application  of  this  definition  may  be  subject  to  dispute, 
but  it  is  stipulated  that  the  Federal  Reserve  Board  shall  have 
the  right  to  determine  or  define  the  character  of  the  paper 
thus  eligible  for  discount  within  the  meaning  of  the  Act. 
"Notes,  drafts  or  bills  covering  merely  investments  or 
issued  or  drawn  for  the  purpose  of  carrying  or  trading  in 
stocks,  bonds  or  other  investment  securities,  except  bonds 
and  notes  of  the  government  of  the  United  States,"  are 
specifically  excluded.  Commercial  paper  represents  actual 
tangible  transactions  of  short  duration,  the  termination  of 
which  will  automatically  furnish  the  means  for  paying  the 
obligation.  Whenever  good  commercial  paper  comes  into 
existence,  it  should  be  possible  for  the  maker  of  that  paper 
to  secure  money  upon  it.  The  fa^t  that  the  ten  per  cent 
limit  is  not  to  apply  to  bills  drawn  against  actual  existing 
values  is  held  to  have  no  serious  significance,  since  the 
existence  of  actual  values  furnishes  ample  security  for  the 
bills,  if  they  are  of  the  sort  just  described.  This  description 
suggests  the  reply  to  the  charge  that  there  is  no  restriction 
placed  on  the  "discount  of  bills  of  exchange  draAvn  in  good 
faith  against  actually  existing  values."  Critics  of  the  new 
law  overlook  the  rathei'  obvious  purpose  of  this  statement 
and  eompletoly  ignore  the  context.  It  is  found  in  the  para- 
graph that  limits  "the  aggregate  amount  of  such  notes 
and  bills  bearing  the  signature  or  endorsement  of  anv  one 


164       OPERATION  OF  THE  NEW  BANK  ACT 

person,  company,  firm  or  corporation  rediscounted  for  any 
one  bank,"  at  any  one  time,  to  no  more  than  "ten  per  cen- 
tum of  the  unimpaired  capital  and  surplus  of  said  bank." 
The  entire  purpose  of  rediscounting  is  to  make  always  pos- 
sible the  financing,  on  a  conservative  basis,  of  the  actual 
transfer  of  goods.  There  is  no  reason  why  a  merchant 
should  not  be  allowed  to  ship  goods  and  then  draw  against 
consignees  without  any  limitations  as  to  amount,  if  he  is  a 
careful  business  man,  does  not  inflate  unduly  the  value  of 
the  goods  and  attaches  the  bills  of  lading,  warehouse  receipt, 
or  other  security  to  the  draft.  The  vital  considerations  are, 
(1)  the  existence  of  an  actual  transaction,  that  is,  the  draw- 
ing of  bills  in  good  faith,  and  (2)  the  evidence  that  the 
values  really  exist,  proof  of  which  may  be  found  in  the 
bill  of  lading  or  other  document  that  should  be  attached  to 
the  bill.  Moreover,  the  section  in  question  is  not  new,  but 
is  taken  with  slight  changes  from  the  National  Bank  Act, 
where  it  may  be  found  in  Section  5200  of  the  Revised 
Statutes. 

Only  Commercial  Paper  Acceptable  as  Security. — To 
the  charge  that  inflation  is  possible  under  the  provision 
allowing  the  rediscount  of  "notes,  drafts  and  bills  of  ex- 
change secured  by  staple  agricultural  products,  or  other 
goods,  wares,  or  merchandise,"  the  same  answer  may  be 
given.  There  must  be  an  actual  commercial  transaction  in 
eveiy  case.  The  bills  must  be  drawn  in  good  faith.  The 
first  requisite  is  that  the  ownership  of  the  goods  must 
change,  and  it  makes  no  difference  whether  they  have  been 
carried  from  one  city  to  another,  or  merely  remain  in  a 
warehouse.  The  important  consideration,  however,  is 
whether  the  occasion  for  making  the  note  or  drawing  the 
draft  is  "an  actual  commercial  transaction,"  or  merely  an 
investment  or  speculation.  If  the  former,  the  paper  may 
be  offered  for  discount  at  a  reserve  bank.  If  the  latter,  it 
may  not  be  so  used.  Speculation  in  wheat  on  the  Chicago 
Board  of  Trade  is  conducted  by  the  transfer  of  warehouse 
receipts  issued  against  grain  in  storage  in  some  Chicago 
elevator,  or  to  be  delivered  there  at  some  specified  future 


POSSIBILITY  OF  INFLATION  165 

date.  Would  commercial  paper  arising  from  such  specu- 
lative transaction  be  eligible  for  rediscount  and  as  security 
for  note  issues?  Is  this  "an  actual  commercial  transac- 
tion?" It  is  clearly  not  so  intended  by  the  spirit  of  the 
law,  and  it  is  the  duty  of  the  Federal  Reserve  Board  in  draft- 
ing its  regulations  effectually  to  debar  such  paper  from 
either  privilege. 

There  must,  then,  be  in  every  case  a  bona  fide  commercial 
transaction,  the  exact  definition  of  which  is  left  to  the  Re- 
serve Board,  but  a  transaction  which  must  be  of  short 
duration,  maturing  within  the  life  of  the  bill,  and  which 
must  not,  at  the  time  of  discount,  exceed  ninety  days.  The 
same  is  true  of  those  bills  drawn  for  agricultural  purposes 
or  based  on  live  stock,  except  that  they  may  still  have  one 
hundred  and  eighty  days  to  run. 

Collateral  is  Short  Time.—  The  fact  that  only  this  short- 
time  paper  is  acceptable  for  rediscounting  is  another  check. 
If  a  bank  discounts  this  paper  with  the  reserve  bank  of  its 
district,  the  maturity  of  that  paper  will  occur  not  more 
than  ninety  days  (or,  on  a  limited  quantity,  one  hundred 
and  eighty  days)  later.  Thus  it  is  impossible  for  a  bank 
to  rediscount  an  unlimited  amount.  The  paper  is*  con- 
tinually coming  due  and  must  be  paid.  Since  collection  will 
doubtless  be  made  through  member  banks,  the  responsibility 
of  making  payment  is  placed  directly  and  immediately  upon 
the  bank  that  discounted  the  paper.  The  right  to  discount 
acceptances  based  on  the  importation  or  exportation  of  goods 
is  limited  to  one-half  the  paid-up  capital  stock  and  surplus 
of  the  bank  for  which  the  rediscounts  are  made ;  and,  as 
suggested  in  another  chapter,  the  practice  will  perhaps  not 
be  rapidly  extended.  Although  the  discount  of  the  direct 
obligations  of  member  banks  was  originally  provided  for, 
the  final  form  of  the  bill  does  not  permit  of  their  use. 

Responsibility  on  Bankers. — This  brief  statement  of 
the  arguments  presented  on  the  two  sides  of  the  subject 
shows  that  most  of  the  discussion  has  been  over  the  tenns 
of  the  law.  Many  have  either  not  read  carefully  its  provi- 
sions, or  else  have  lost  sight  of  the  most  important  fact  in 


1G6       OPERATION  OF  THE  NEW  BANK  ACT 

the  whole  problem,  which  is  that  no  system  can  eliminate 
the  personality  of  the  banker.  Banking  law  is,  in  all  coun- 
tries, far  less  important  than  banking  practice.  The  only 
laws  of  significance  governing  the  operations  of  the  Bank 
of  England  have  to  do  with  checks  on  the  issue  of  notes. 
The  great  structure  of  credits,  by  whose  aid  the  larger  part 
of  the  business  of  the  country  is  performed,  receives  almost 
no  legal  recognition.  It  is  restrained  in  its  operations  by 
precedent  and  by  the  force  of  public  opinion. 

A  reorganization  of  our  system  necessitates  the  estab- 
lishment of  numerous  restraints  in  the  law  itself.  Note 
issues  must  be  protected,  examinations  of  the  banks  and 
reports  by  them  must  be  provided  for,  and  in  many  other 
ways  the  banks  must  be  brought  under  governmental  con- 
trol and  supervision.  But  discretion  in  the  operation  of  the 
plan  must  be  lodged  somewhere.  Legal  machinery  can  not 
take  the  place  of  individual  judgment,  even  though  safe- 
guards may  be  imposed.  Individual  bankers  must  pass 
upon  each  loan,  and  either  an  individual,  or  some  responsible 
group  with  authority,  must  be  allowed  to  decide  the  broader 
problems  of  policy  that  will  constantly  arise. 

The  real  responsibility  must  rest,  first  of  all,  not  in  the 
law  but  in  the  judgment  of  the  bankers  themselves.  Under 
the  Act  the  officials  of  each  member  bank  must  first  pass 
upon  the  paper.  Inasmuch  as  they  are  subject  to  careful 
examination  and  limited  by  the  law  in  various  ways,  and 
especially  because  any  loss  thereon  will  fall  entirely  upon 
them,  they  will  doubtless  hesitate  fully  as  much  as  at  present 
to  lend  to  any  one  who  does  not  give  adequate  security. 
Since  only  commercial  paper,  as  defined  by  the  Federal  Re- 
serve Board,  may  be  rediscounted,  perhaps  even  greater 
care  will  be  exercised  in  the  future  than  has  been  in  the 
past.  All  paper  that  is  rediscounted  is  subject  to  the  scru- 
tiny of  the  reserve  bank  to  which  it  is  presented.  In  this 
laborious  and  responsible  task  the  existence  of  branch  offices 
will  be  a  distinct  help.  Directors  of  branches  will  be  able 
to  know  local  conditions.  They  will  be  able  to  form  very 
definite  opinions  as  to  the  care  which  each  member  bank 
is  using  in  the  conduct  of  its  business,  and  will  be  in  a  posi- 


POSSIBILITY  OF  INFLATION  167 

tion  to  control  discounting  by  any  bank  that  shows  symp- 
toms of  weakness.  Oversight  by  each  reserve  bank  will 
therefore  be  a  definite  check  on  the  rediscounting  of  poor 
paper  by  member  banks. 

Reserve  Board  Must  Supervise. — The  Federal  Reserve 
Board,  to  which  application  must  be  made  for  notes  secured 
by  the  discounted  commercial  paper,  will  not  be  in  a  position 
to  pa.ss  judgment  effectively  on  the  quality  of  that  paper; 
nor  does  the  law  intend  that  it  should  be  called  upon  to  do 
so.  Its  work  will  be  that  of  determining  whether,  on  the 
whole,  business  conditions  Avarrant  the  issue  of  as  many 
notes  as  are  applied  for.  If  evidence  of  over-expansion 
appears,  checks  that  are  within  its  power  may  be  applied. 
These  checks  have  been  stated  in  the  chapters  discussing 
the  powers  of  the  Federal  Reserve  Board,  and  the  way 
in  which  they  are  exercised  has  been  described ;  but  they 
may  be  again  enumerated.  The  Reserve  Board  designates 
one-third  of  the  directors  of  each  reserve  bank  and  is  thus 
in  a  position  to  determine  the  trend  of  action  of  the  reserve 
banks ;  may  examine  the  accounts  and  books  of  reserve  banks 
and  of  mem])er  banks  at  its  discretion ;  may  permit,  or  even 
require,  one  reserve  bank  to  rediscount  for  another;  may 
suspend  or  remove  officers  or  directors  of  the  reserve  banks 
for  cause ;  may  require  the  writing  off  of  doubtful  or  worth- 
less assets  b}'  the  reserve  banks ;  may  impose  restrictions, 
limits  and  regulations  upon  rediscounts  by  reserve  banks ; 
may  raise  the  rate  of  interest  paid  by  each  reserve  bank  for 
the  notes  it  receives;  may  require  a  reserve  bank  to  furnish 
information  as  to  the  condition  of  any  member  bank  in  its 
district.  Most  important  of  all,  it  is  to  review  and  determine 
the  rates  of  discount  to  be  charged  member  banks  by  the 
reserve  bank,  and  may  insist  upon  such  changes  in  that  rate 
as  may  be  necessary  to  check  undue  expansion  in  redis- 
counts. Through  its  general  power  of  direction  and  over- 
sight, it  may  direct  certain  open-market  operations  by  the 
reserve  banks,  which  may  be  used  to  advantage  in  checking 
any  tendency  to  inflation. 

Methods  of  Checking  Inflation. — T;Pt  us  suppose  that 
there  arises  a  tendency  to  over-expansion  of  business  in  one 


168      OPERATION  OF  THE  NEW  BANK  ACT 

of  the  reserve  districts.  Primarily  the  individual  bankers 
are  responsible,  and  it  is  their  duty  as  bankers  to  scrutinize 
every  application  for  a  loan  with  great  care  and  perhaps 
to  raise  the  rates  charged  to  borrowers.  If  carelessness 
or  poor  judgment  among  the  individual  banks  permits  the 
system  to  get  beyond  their  control,  the  reserve  bank  of  the 
district  will  use  its  influence.  The  officials  and  directors 
of  this  institution  are  experienced  bankers.  Each  director 
of  Class  A  will  be  able  to  control  the  policy  of  his  own  bank, 
and  by  his  suggestion  and  advice  indicate  to  other  bankers 
of  the  district  the  attitude  of  the  reserve  bank  toward  gen- 
eral business  conditions.  The  rates  for  rediscount  may  be 
raised,  and  commercial  paper  offered  as  collateral  will  be 
more  strictly  scrutinized. 

The  Federal  Reserve  Board  will,  of  course,  be  closely 
watching  developments  within  this  district.  If  expansion 
is  going  on  too  rapidly  for  safety,  it  may  reject  applications 
for  notes,  raise  the  rate  of  interest  that  must  be  paid  by  the 
reserve  bank  that  receives  them,  and  insist  upon  a  higher 
discount  rate  to  be  charged  member  banks  within  the  dis- 
trict. If  the  difficulty  is  with  a  particular  member  bank 
or  banks,  special  examinations  and  reports  may  be  ordered. 
If  there  should  be  gross  negligence  or  incompetence  among 
the  officials  or  directors  of  the  reserve  bank,  the  inefficient 
men  may  be  removed  by  the  Reserve  Board  and  new  elec- 
tions ordered  or  appointments  made.  If  outside  help  is 
needed,  the  other  reserve  banks  may  be  permitted  or  required 
to  rediscount  for  the  one  that  is  in  difficulty. 

Note  Issues  not  Always  Profitable. — Most  critics  fear 
that  inflation  will  come  through  an  excessive  note  issue,  but 
it  must  be  remembered  that  it  will  not  always  be  to  the 
advantage  of  the  reserve  banks  to  issue  Federal  reserve 
notes.  So  long  as  possible  or  advisable,  they  will  pay  out 
other  forms  of  money.  National  bank  notes  will  be  sent 
back  to  the  bank  of  issue  or  to  the  redemption  agency  at 
Washington,  but  the  bond-secured  notes  of  the  resei've  banks 
will  be  used  whenever  possible.  Even  lawful  money  may 
be  given  out  if  reserves  are  large  or  if  the  demand  is  urgent, 
since  any  insistence  on  giving  its  own  bond-secured  notes  or 


POSSIBILITY  OF  INFLATION  169 

Federal  reserve  notes  would  merely  mean  the  immediate 
presentation  of  the  latter  for  redemption  in  lawful  money. 
The  delay  secured  by  refusing  the  lawful  money  at  the  outset 
would  be  of  little  or  no  importance.  The  reserve  banks  may 
even  be  in  such  a  strong  condition  that  they  will  consider 
it  entirely  safe  and  proper  to  pay  out  freely  their  holdings 
of  gold  and  other  lawful  money. 

Effect  of  Interest  on  the  Notes. — Besides  the  Federal 
reserve  notes  may  be  secured  for  issue  only  by  the  deposit 
of  collateral  and  upon  them  the  reserve  bank  must  pay 
interest,  thus  making  their  use  expensive.  In  fact,  this 
interest  may  answer  the  purpose  of  the  tax  imposed  on 
extra  note  issues  in  many  countries  and  on  the  emergency 
circulation  provided  for  by  the  Aldrich-Vreeland  Act  in 
the  United  States.  The  amount  of  this  interest  rate  is  to  be 
fixed  by  the  Reserve  Board  and  may  be  raised  or  lowered 
at  its  discretion.  If  the  board  fears  an  over-issue  by  any 
reserve  bank  it  may  begin  charging  it  a  higher  interest 
on  the  notes  it  issues.  It  even  appears  possible  to  charge 
different  interest  rates  to  different  reserve  banks  at  the 
same  time. 

It  is  thus  clear  that  the  real  check  against  inflation  rests 
in  the  judgment  of  some  responsible  individual  or  group.  In 
the  past,  each  banker  has  been  responsible  for  the  proper 
management  of  his  own  institution.  Even  if  he  were  in- 
capable, he  might  be  able  to  escape.  Other  bankers  would 
not  dare  allow  him  to  fail,  since  his  ruin  would  involve  the 
rest.  When  several  banks  of  a  city  or  of  a  section  of  the 
country  were  M-eak,  there  has  been  no  one  responsible.  Diffi- 
culties have  often  developed  that  could  and  would  have  been 
avoided  under  a  different  banking  organization. 

Whether  the  new  law  will  prevent  a  recurrence  of  such 
troubles  it  is  impossible  to  say  with  absolute  certainty.  As 
before,  we  must  emphasize  the  importance  of  two  factors. 
The  bankers  are  primarily  responsible  within  each  district. 
For  the  country  as  a  whole  we  must  depend  upon  the  Federal 
Reserve  Board.  The  ability,  judgment,  tact  and  discretion 
of  these  two  groups  will  detennine  the  outcome. 


CHAPTER  XVII 

Open  Market  Operations 

Purposes  of  the  Law  Summarized. — The  preamble  of 
our  new  law  describes  it  as  "An  Act  to  provide  for  the 
establishment  of  Federal  reserve  banks,  to  furnish  an  elastic 
currency,  to  afford  means  of  rediscounting  commercial 
paper,  to  establish  a  more  effective  supervision  of  banking 
in  the  United  States,  and  for  other  purposes." 

Each  reserve  bank  will  be  a  medium  through  which  these 
objects  are  to  be  attained  for  its  district.  By  discounting 
paper  and  issuing  notes,  each  will  furnish  elastic  currency, 
and  by  holding  a  part  of  the  reserves  of  its  members  will 
concentrate  the  cash  of  the  country  where  it  can  be  used. 
Funds  not  immediately  demanded  by  members  will  be  in- 
vested along  such  lines  as  the  Act  permits.  Rediscounting, 
issuing  notes  and  investing  surplus  funds  will  constitute  the 
bulk  of  its  work. 

Reserve  Banks  Must  Forestall  Trouble. — But  this  is 
only  a  part  of  its  duties.  In  so  far  as  possible  each  reserve 
bank  must  foresee  trouble  in  the  money  market  and  when 
trouble  arises  must  furnish  assistance.  These  difficulties 
may  arise  either  within  the  United  States  or  from  without, 
but  no  matter  what  their  origin,  they  must  be  foreseen, 
and  checked.  Trouble  at  home  may  arise  because  banks  lend 
on  inadequate  security,  or  because  rumor  of  the  weakness  of 
one  or  several  banks  has  been  circulated,  perhaps  without 
foundation.  Withdrawals  of  gold  to  other  countries,  when 
better  interest  rates  are  offered,  may  lessen  the  supply 
available  for  local  uses  and  so  hamper  business  through  the 
inability  of  the  banks  to  lend.  Such  contingencies  as  these 
will  make  it  necessary  for  the  reserve  banks  to  be  contin- 
ually on  the  alert.  They  will  be  responsible  and  machinery 
should  be  placed  at  their  disposal  that  will  make  it  possible 
for  them  to  do  what  is  expected.  Otherwise  they  may  be 
170 


OPEN  MARKET  OPERATIONS  171 

compelled  to  watch  idly  while  trouble  develops  to  a  poiut 
whore  nothing  can  check  its  spread. 

Methods  Employed  Abroad. — This  power  to  prevent 
the  development  of  trouble  is  used  very  effectively  in  other 
countries,  and  involves  three  general  features :  first,  a  close 
supervision  of  all  current  market  operations ;  second,  ability 
to  conserve  the  gold  supply  of  the  country;  and  third,  the 
power  to  control  the  movement  of  the  foreign  exchanges. 
Each  of  these  three  may  be  examined  in  order.  Inasmuch 
as  the  third  is  in  practice  a  corollary  of  the  second,  these 
two  may  be  discussed  together.  Supervision  of  market 
operations  may  be  accomplished  by  giving  to  the  central 
institution  the  right  to  deal  directly  with  the  public.  This 
is  the  practice  of  the  Bank  of  England  and  other  leading 
central  banks.  In  England,  any  person,  firm  or  company 
constituting  a  good  credit  risk  may  secure  loans  and  dis- 
counts at  the  Bank  of  England.  In  Germany,  all  classes 
of  people  may  deal  with  the  Reichsbank  and  about  forty  per 
cent  of  the  total  amount  of  the  discounts  of  that  bank  are 
made  for  the  general  public,  as  distinct  from  banks  and 
bankers.  Of  its  6(),700  customers  in  1910,  only  2,400  were 
banks.  Thus,  in  numbers,  less  than  four  per  cent  were  banks, 
while  the  balance  was  made  up  of  merchants,  manufactur- 
ers, farmers  and  others.  About  thirty  per  cent  of  the  dis- 
counts of  the  Bank  of  France  are  made  for  the  general 
public,  and  the  other  seventy  per  cent  come  through  the 
banks. 

Advantages  Gained. — This  ability  to  deal  directly  with 
the  pul)lic  h;is  a  (loul)le  advantage.  Funds  of  the  central 
institution  are  kept  constantly  in  use,  and  thus  the  earning 
power  of  the  bank  is  increased.  If  these  funds  are  properly 
invested  in  liquid  securities,  they  may  be  turned  into  cash 
whenever  such  action  seems  advisabl(>.  The  second  advan- 
tage is  that  the  central  institution  may,  by  changing  the  rate 
at  which  it  does  business  with  the  public,  give  frequent 
notice  of  its  estimate  of  general  Inisiness  conditions,  and  also 
compel  the  other  banks  to  adopt  conservative  inethods. 
The  central  bank  becomes  a  direct  competitor  of  the  others, 


172       OPERATION  OF  THE  NEW  BANK  ACT 

a  fact  which  is  not  at  all  to  their  liking,  but  the  daily  con- 
tact with  business,  which  is  thus  secured,  is  very  valuable  in 
making  possible  a  careful  control  of  the  money  market. 

This  situation  in  other  countries  has  brought  about  the 
establishment  of  what  is  known  as  ''the  bank  rate,"  which 
is  merely  a  nominal  rate  at  which  the  bank  announces  that 
it  will  rediscount  any  amount  of  paper  brought  to  it  by 
the  other  banks  of  the  community.  It  is  not  usually  the  rate 
at  which  discounting  is  being  done  for  the  public,  that  rate 
being  known  as  "the  market  rate"  or  "the  private  discount 
rate. ' '  Market  rate  is  usually  lower  than  bank  rate,  which  is 
largely  a  business  barometer.  When  the  bank  rate  is  al- 
tered, as  it  is  from  time  to  time,  the  change  is  interpreted 
as  an  estimate  of  general  business  conditions  by  the  direc- 
torate of  the  central  institution,  and  as  showing  the  prices 
that  the  banks  of  the  community  must  pay  if  they  find  it 
necessary  to  apply  for  rediscounts.  Bank  rate  is  not  the 
rate  at  which  the  central  bank  does  business  with  the  public, 
since  it  regularly  competes  with  the  other  banks  at  the 
market  rate. 

Controlling  the  Gold  Supply. — The  second  influence 
by  which  the  leading  foreign  institutions  prevent  the  ap- 
pearance of  difficulties  is  by  a  careful  conservation  of  their 
supply  of  gold.  This  is  accomplished  in  a  variety  of  ways. 
The  first  is  by  raising  the  bank  rate  and  through  it  the 
market  rate  to  such  a  point  that  excessive  withdrawals  of 
gold  from  the  vaults  of  the  central  bank,  and  from  the 
country,  are  discouraged.  Another  method  is  by  paying  out 
bank  notes  rather  than  gold.  The  large  foreign  institutions 
also  sell  securities  which  they  may  chance  to  hold,  receiving 
in  return  gold  which  is  thus  drawn  into  their  o^vn  vaults 
and  will  be  parted  with  only  at  a  high  price.  Gold  may  be 
borrowed  in  the  open  market  from  other  institutions,  col- 
lateral security  of  one  sort  or  another  being  furnished, 
when  necessary.  In  many  eases  the  competition  for  gold 
in  the  weekly  public  gold  market  at  London  becomes  keen, 
and  the  prices  rise  to  a  high  point.  In  a  few  cases  also  these 
banks  advance  gold,  free  of  interest,  to  importers  who  agree 


OPEN  MARKET  OPERATIONS  173 

to  reimburse  the  bank  as  soon  as  their  shipments  arrive. 
The  importer  thus  saves  interest  during  the  period  while 
the  gold  is  in  transit — an  item  which  is  one  of  the  most 
important  in  determining  importations.  The  Bank  of  Ger- 
many, the  Bank  of  Belgium  and  the  Bank  of  France  also 
hold  themselves  ready  at  all  times  to  sell  foreign  exchange 
at  a  point  below  the  gold  export  point.  They  accomplish 
this  by  accumulating  during  easy  times  a  supply  of  credits 
in  foreign  countries,  against  which  they  may  later  sell 
drafts. 

Reserve  Banks  closely  Limited  by  the  New  Law. — 
This  brief  recital  of  the  methods  iTsed  by  the  large  banks 
in  foreign  countries  suggests  some  of  the  devices  that  might 
be  employed  by  the  reserve  banks.  Their  actions,  how- 
ever, are  defined  by  the  law  and  in  it  there  is  clear  evidence 
of  an  intention  to  restrict  them  within  close  limits.  One 
of  the  earlier  drafts  of  the  bill  specifically  denied  to  them 
the  right  to  deal  with  any  one  except  the  government  and 
member  banks.  As  the  Act  finally  passed  this  limitation 
was  not  included,  but  since  there  is  no  definite  authority 
to  deal  with  the  public,  except  in  certain  specified  partic- 
ulars, it  is  safe  to  assume  that  direct  borrowing  and  lending 
in  the  general  market  will  not  be  sanctioned  by  the  courts. 
There  is  a  section  of  the  Act  devoted  to  what  are  called 
"open-market  operations,"  and  a  careful  reading  of  it  will 
show  that  there  are  a  number  of  different  ways  in  which 
the  reserve  banks  may  deal  with  the  public.  There  is, 
however,  no  authorization  under  which  they  may  discount 
or  lend  directly  to  private  individuals. 

A  discussion  of  the  powers  granted  and  the  methods 
that  may  be  used  to  prevent  difficulties,  or  to  correct  them 
when  they  appear,  may  be  taken  up  under  two  general 
heads:  (1)  the  relations  which  the  reserve  banks  may  have 
with  the  general  market,  both  in  the  United  States  and 
abroad,  through  which  it  may.  from  day  to  day,  influence 
the  money  market;  and  (2)  the  devices  by  which  it  may. 
when  necessars',  protect  its  gold  supply  from  withdrawals 
by  other  countries.    The  first  of  these  topics  will  be  treated 


174       OPERATION  OF  THE  NEW  BANK  ACT 

in  this  chapter  and  the  second  in  the  following  one  entitled 
"Control  of  the  Gold  Supply." 

Dealings  in  Cable  Transfers. — The  first  point  of  con- 
tact with  the  money  market  is  in  the  authorization  to  "pur- 
chase and  sell  in  the  open  market,  at  home  or  abroad,  either 
from  or  to  domestic  or  foreign  banks,  firms,  corporations  or 
individuals,  cable  transfers  and  bankers'  acceptances  and 
bills  of  exchange  of  the  kinds  and  maturities  by  this  Act 
made  eligible  for  rediscount,  with  or  without  the  indorse- 
ment of  a  member  bank."  This  section  clearly  does  not 
authorize  the  reserve  bank  to  engage  in  domestic  business 
to  any  great  extent.  Cable  transfers  have,  of  course,  to 
do  with  foreign  transactions.  They  are  orders  sent  to  or 
from  a  foreign  country  for  the  immediate  deliver}^  of  cash. 
Because  of  their  quick  transmission  they  save  the  loss  of 
time  that  is  involved  if  an  order  is  sent  by  mail. 

The  right  to  deal  in  these  cables  will  give  to  the  reserve 
banks  the  power  to  influence  movements  of  cash  into  and 
out  of  the  country  that  may  at  times  be  exceedingly  valu- 
able. The  way  in  which  this  will  be  accomplished  will  be 
discussed  in  the  next  chapter,  and  at  this  point  we  may 
merely  observe  that  the  power  to  make  such  purchases  (1) 
gives  a  convenient  means  of  transferring  funds  to  or  from 
a  foreign  country,  and  (2)  makes  the  reserve  banks  com- 
petitors of  those  institutions  that  now  deal  in  foreign  ex- 
change. How  successfully  they  may  be  able  to  compete 
with  the  older  institutions  is  by  no  means  certain. 

Bankers'  Acceptances. — The  second  of  the  items  is 
bankers'  acceptances.  In  Section  13  any  member  bank 
is  authorized  to  "accept  drafts,  or  bills  of  exchange  drawn 
upon  it  and  growing  out  of  transactions  involving  the 
importation  or  exportation  of  goods  having  not  more  than 
six  months'  sight  to  run."  Elsewhere  attention  has  been 
called  to  the  fact  that  this  authorization  to  accept  drafts 
will  probably  not  be  used  extensively  for  the  present.  In 
so  far  as  it  is  used,  either  in  the  present  or  in  the  future, 
it  is  confined  to  foreign  transactions,  and  the  acceptances 
bought  by  the  reserv'e  banks  may  be  used  in  building  up 


OPEN  MARKET  OPERATIONS  175 

foreign  accounts,  which  may  be  of  value  in  times  of  stress. 
The  reserve  banks  may  enter  into  active  competition  with 
the  other  banks  for  these  acceptances  and,  if  it  can  offer  a 
better  price,  may  be  able  to  exercise  considerable  influence 
over  the  market  for  this  paper  and  indirectly  over  other 
transactions. 

Significance  of  Purchases  of  Bills  of  Exchange. — 
Third  on  the  list  are  bills  of  exchange,  which  must  be  only 
of  the  kinds  acceptable  for  rediscount  under  the  terms  of 
the  Act.  As  our  banlis  may  accept  only  drafts  based  on 
imports  and  exports,  the  bills  that  are  here  authorized  must 
be  either  (1)  acceptances  by  our  banks,  the  drafts  being 
drawn  in  connection  with  foreign  trade,  (2)  drafts  on 
foreign  bankers  or  individuals,  or  (3)  drafts  on  individuals 
within  the  United  States.  It  is  not  necessary  for  any  of 
them  to  have  the  endorsement  of  a  member  bank.  The  first 
of  the  three  is  the  bankers'  acceptance  just  described.  The 
second  group  is  much  larger  and  includes  all  bills  drawn 
on  foreign  banks  and  individuals.  As  the  drafts  may  be 
bought  from  or  sold  to  "domestic  or  foreign  banks,  firms, 
corporations,  or  individuals,"  the  reserve  banks  may  com- 
pete freely  with  all  other  banks  in  the  field  of  foreign  ex- 
change. The  third  group  is  at  present  not  a  large  one  in 
the  United  States.  The  drawing  of  a  draft  on  an  individual 
often  means  that  his  credit  is  weak.  Usually  the  creditor 
carries  tlie  obligation  as  a  book  account,  perhaps  offering 
a  discount  for  cash  wnthin  a  specified  time.  To  get  this 
discount  the  debtor  then  borrows  the  amount  from  his  bank 
on  the  security  of  his  own  commercial  credit.  The  adop- 
tion of  the  system  of  drawing  on  debtors  either  at  sight  or 
on  time  would  mean  a  radical  reorganization  of  American 
business  methods,  but,  if  once  introduced,  would  place  the 
reserve  banks  in  a  position  to  compete  effectively  with  the 
other  banks  for  a  large  part  of  the  public's  business. 

Buying  and  Borrowing  Gold. — Five  paragraphs  at  the 
end  of  the  section  on  open  maiket  operations  repeat  a  num- 
ber of  provisions  found  elsewhere  in  the  Act  but  add  sev- 
eral that  are  not  stated  in  otlior  sootions.     Those  that  are 


176       OPERATION  OF  THE  NEW  BANK  ACT 

repetitions  are  discussed  in  other  chapters  and  need  not 
be  again  examined.  Of  the  new  provisions  of  importance, 
the  first  is  the  right  granted  to  reserve  banks  of  dealing  in 
gold  coin  and  bullion,  at  home  or  abroad.  When  gold  is 
scarce  the  resei*ve  banks  may  bid  for  it  at  the  weekly  London 
gold  auction  or  elsewhere,  in  competition  with  the  other 
large  banks  of  the  world.  Payment  for  the  gold  may  be 
made  in  any  form  acceptable,  but  presumably  with  the  pro- 
ceeds from  the  sale  of  bills  that  have  been  held  for  this  very 
purpose  with  its  foreign  correspondents  or  agencies,  A 
second  new  provision  is  the  right  to  borrow  gold,  giving, 
when  necessary,  acceptable  security.  This  is  similar  to  one 
of  the  practices  of  the  Bank  of  England,  and  will  be  dis- 
cussed in  the  next  chapter. 

Foreign  Correspondents  and  Agencies. — A  third  au- 
thorization is  the  grant  of  power,  "with  the  consent  of  the 
Federal  Resei've  Board,  to  open  and  maintain  banking  ac- 
counts in  foreign  countries,  appoint  correspondents,  and 
establish  agencies  in  such  countries  wheresoever  it  may 
deem  best  for  the  purpose  of  purchasing,  selling,  and  col- 
lecting bills  of  exchange  and  to  buy  and  sell  with  or  with- 
out its  indorsement,  through  such  correspondents  or 
agencies,  bills  of  exchange  arising  out  of  actual  commercial 
transactions  which  have  not  more  than  ninety  days  to  run 
and  which  bear  the  signature  of  two  or  more  responsible 
parties."  The  foreign  agencies  will  furnish  an  advan- 
tageous outlet  for  exchange  purchased  in  the  United  States 
and  also  a  convenient  means  of  keeping  in  close  touch  with 
foreign  markets.  Opportunity  is  offered  through  them  of 
competing  with  foreign  banks,  but  of  much  more  value  is 
the  fact  that  these  agencies  will  stand  ready  to  purchase 
drafts  on  American  bankers.  As  indicated  in  the  chapter 
on  "Foreign  Acceptances"  there  may  be  some  discrimina- 
tion against  "dollar  drafts."  Foreign  agencies  of  our  re- 
serve banks  will  be  able  to  counteract  this  influence  and  by 
purchasing  such  drafts  raise  their  standing. 

Buying  and  Selling  Securities. — The  fourth  and  last 
important  point  of  contact  with  the  public  is  through  the 


OPEN  MARKET  OPERATIONS  177 

power  "to  buy  and  sell  at  home  or  abroad,  bonds  and  notes 
of  the  United  States,  and  bills,  notes,  revenue  bonds,  and 
warrants  with  a  maturity  from  date  of  purchase  not  ex- 
ceeding six  months,  issued  in  anticipation  of  the  collection 
of  taxes  or  in  anticipation  of  the  receipt  of  assured  revenues 
by  any  State,  county,  district,  political  subdivision,  or 
municipality  in  the  continental  United  States,  including 
irrigation,  drainage  and  reclamation  districts."  Competi- 
tion with  the  other  banks  in  the  purchase  of  United  States 
securities  and  a  limited  group  of  State  and  municipal  secu- 
rities is  thus  made  possible.  While  this  may  be  a  disad- 
vantage to  some  member  banks  and  may  perhaps  result  in 
better  prices  for  some  of  the  securities,  the  significance  lies 
in  the  possibihty  of  each  reserve  bank  acquiring  a  supply 
of  short-term  bonds  and  notes  which  may  readily  be  sold  to 
replenish  the  cash  resei*ves. 

These  various  points  of  contact  with  the  market  do  not 
at  first  sight  appear  of  much  importance.  They  contain, 
however,  great  possibilities  for  the  future.  Through  the 
right  to  buy  and  sell  exchange  and  certain  securities,  both 
at  home  and  abroad,  prices  may  be  influenced,  gold  move- 
ments controlled  and  the  standing  of  American  banks  in 
other  countries  raised.  Doubtless  the  extension  of  Amer- 
ican trade  will  also  be  encouraged  if  drafts  on  United  States 
banks  are  given  more  recognition.  Control  over  the  money 
market  in  the  United  States  will  depend  largely  on  whether 
American  business  men  will  modify  their  present  methods, 
substituting  the  draft  for  the  statement  of  account  as  a 
means  of  collection.  Perhaps  with  a  little  encouragement 
from  the  reserve  banks  this  may  be  brought  about,  but  such 
an  outcome  appears  less  probable  when  we  remember  that 
the  reserve  banks  will  be  managed  by  the  bankers  them- 
selves. Unless  forced  to  do  so  by  the  Reserve  Board  they 
are  not  apt  to  encourage  such  competition. 


\i 


CHAPTER  XVIII 

Control  of  the  Gold  Supply 

Domestic  Withdrawals  the  Least  Serious. — With- 
drawals of  gold  from  the  reserve  banks  can  be  classified 
under  two  general  heads.  In  the  first  place  there  are  the 
withdrawals  occasioned  directly  or  indirectly  by  the  opera- 
tions of  the  member  banks  in  handling  domestic  business. 
These  withdrawals  are  the  less  dangerous,  because  the  gold 
has  merely  been  shifted  from  one  part  of  the  banking  sys- 
tem to  another.  The  system  may  not  have  been  seriously 
weakened  thereby,  and  from  past  experience  it  seems  reas- 
onable to  presume  that  so  long  as  the  gold  remains  within 
the  United  States  it  is  merely  a  question  of  time  until  it 
will  return  to  the  reserve  banks.  When  the  special  demands 
of  business  are  over,  the  money  will  no  longer  be  needed 
to  finance  trade.  If  panic  has  caused  the  withdrawals,  the 
disappearance  of  fear  will  end  hoarding.  The  gold  will 
then  return  to  member  banks  and  will  be  deposited  by 
them  with  the  reserve  institutions  in  the  same  proportions 
as  before. 

Far  more  serious  is  the  second  drain  upon  the  gold 
supply  of  the  reserve  banks.  If  the  gold  leaves  the  United 
States,  its  recoveiy  is  not  so  easy.  As  we  have  already  ex- 
plained, the  leading  countries  of  the  world  employ  numer- 
ous devices  to  control  their  supplies  of  gold  and  to  attract 
more  in  time  of  need.  Gold  does  not  flow  from  one  nation 
to  another  purely  in  response  to  trade  demands,  nor  does 
it  move  merely  when  exchange  rates  are  favorable.  At 
times  it  will  be  firmly  held  and  often  it  is  arbitrarily  at- 
tracted by  inducements  that  have  no  immediate  connec- 
tion with  commercial  needs.  To  offset  foreign  operations 
our  new  law  introduces  a  number  of  features  which  are 
intended  to  aid  us  in  conserving  our  stock  of  gold  and 
even  to  make  possible  additions  to  the  supplies  on  hand. 
In  earlier  chapters  some  of  these  have  been  mentioned,  but 
usually  in  connection  with  other  problems.  Hence  a  re- 
178 


CONTROL  OF  THE  GOLD  SUPPLY  179 

statement  showing  their  bearing  upon  the  prevention  of 
gold  importations  is  in  order. 

The  Discount  Rate  as  a  Protection. — First  and  most 
important  is  the  right  of  reserve  banks  to  establish  a  rate 
of  discount  sufficiently  high  to  discourage  extensive  redis- 
counting.  The  value  of  this  in  checking  loans  within  the 
United  States  has  already  been  pointed  out.  Raising  the 
discount  rate  results  in  raising  the  interest  rate  at  which 
biLsiness  men  can  borrow.  This  discourages  a  further  ex- 
pansion of  loans.  The  effect  of  the  higher  discount  rate 
is  not  limited  to  local  business.  One  of  the  most  important 
results  is  to  discourage  foreign  institutions  from  borrow- 
ing here  to  lend  abroad.  It  will  in  addition  make  it  less 
profitable  to  withdraw  any  accounts  they  may  already  have 
with  banks  here.  If  there  is  any  hesitancy  on  the  part  of 
the  directors  of  the  reserve  bank  to  take  such  action,  the 
Federal  Reserve  Board  may  compel  it — a  fact  of  much 
importance  since  the  majority  of  the  directors  of  any 
reserve  bank  are  chosen  by  the  member  banks,  and  hence 
might  be  averse  to  an  increase  in  the  discount  rate  which 
their  own  banks  are  charged  for  accommodations. 

Since  the  member  bank  securing  the  notes  gets  them 
only  by  rediscounting  commercial  paper,  the  maturity  of 
that  paper  will  compel  settlement  with  the  reserve  bank 
for  the  amount  originally  secured.  Other  commercial 
paper  may  be  offered  by  the  reserve  bank  if  such  a  substitu- 
tion is  acceptable  to  the  Federal  reserve  agent,  or  the 
amount  due  must  be  paid  in  cash.  If  the  notes  originally 
issued  have  been  redeemed  for  gold,  some  other  form  of 
cash  may  be  presented.  Perhaps  gold  will  be  included, 
and  thus  the  gold  supply  of  the  resen-e  banks  will  be  re- 
stored ;  or  if  other  forms  of  money  are  offered,  they  may  be 
redeemed  by  the  reserve  bank  at  the  Treasury'  in  gold  and 
thus  the  same  purpose  accomplished. 

Federal  Reserve  Notes  May  Cause  Gold  Exports. — 
This  seems  to  indicato  that  there  is  little  to  fear  from  gold 
withdrawals  through  rediscounting,  but  in  practice  there 
may  be  difficulty.  Some  of  the  pro\nsionR  of  the  law  may 
actually  force   presentation   of  the  notes  for  redemption. 


180       OPERATION  OF  THE  NEW  BANK  ACT 

Gold  may  thus  be  secured  for  export,  and  when  it  leaves 
the  country  its  return  is  difficult  to  secure,  even  though  our 
needs  may  be  great.  Thus  the  issue  of  reserve  notes  under 
the  conditions  that  are  imposed  may  not  be  a  help  in  con- 
trolling our  gold  supply,  but  may  even  be  a  hindrance. 
Congress  attempted  to  prevent  inflation  of  credit  by  not 
allowing  the  use  of  the  reserve  notes  as  legal  raserves.  The 
result  may  be  to  hasten  their  redemption  in  gold  or  other 
lawful  money  before  the  maturity  of  the  paper  discounted 
to  secure  them.  If  gold  should  be  withdrawn  and  exported, 
it  may  be  necessary  for  the  Federal  Reserve  Board  to  check 
the  movement  by  raising  still  further  the  discount  rate,  or 
by  applying  some  one  of  the  other  methods  later  described. 

Buying  Gold  and  Selling  Securities. — Another  influence 
is  the  power  to  buy  gold  abroad.  This  gold  may  be  pur- 
chased by  means  of  credits  secured  by  the  purchases  of 
foreign  bills  described  in  the  preceding  chapter.  The  gold 
will  be  held  abroad  unless  the  condition  of  the  foreign  ex- 
change market  makes  it  more  profitable  to  import  it  rather 
than  sell  drafts  against  it,  or  unless  the  reserve  bank  desires 
to  increase  its  stock  of  gold.  Still  another  resource  is  the 
power  to  sell  some  of  its  securities.  This  ability  is  one  of  the 
most  important  possessed  by  the  Bank  of  England,  which 
frequently  sells  large  quantities  of  consols,  the  standard 
British  government  bond.  In  our  new  Act  the  one-year 
three  per  cent  United  States  notes,  for  which  the  two  per 
cent  United  States  bonds  may  be  exchanged,  are  the  most 
important  salable  asset  at  such  times.  They  mature  within 
one  year,  can  always  be  sold  at  near  par,  and  hence  will  be 
more  available  at  such  times  than  long-tenn  bonds.  The 
fact  that  they  mature  so  soon,  however,  is  also  a  disadvan- 
tage, since  the  reserve  bank  is  obligated  by  an  agreement 
with  the  Treasury  Department  to  purchase  other  notes  at 
the  maturity  of  the  ones  under  discussion,  if  the  Secretary 
of  the  Treasury  desires  it. 

Next  in  importance  are  the  short-term  State  and  munici- 
pal securities  described  in  the  last  chapter.  While  not  so 
good  as  United  States  notes  they  will  always  bring  a  fair 
price.    Reserve  banks  may  also  borrow  gold,  giving,  when 


CONTROL  OF  THE  GOLD  SUPPLY  181 

necessary,  acceptable  security.  This  borrowing  may  be  done 
in  the  home  market  or  abroad.  If  done  abroad  it  will  make 
possible  the  sale  in  the  United  States  of  exchange  below 
the  export  point  and  thus  prevent  a  movement  of  gold  out 
of  the  country.  If  purchased  in  the  United  States  the  gold 
supply  of  the  market  will  be  turned  into  the  hands  of  the 
reserve  banks,  and  released  again  only  on  such  terms  as 
they  may  choose  to  impose.  This  will  result  in  raising  the 
general  discount  rate  within  the  United  States,  and  gold 
exports  will  be  discouraged.  The  collateral  offered  for  the 
loan  will  probably  be  United  States  and  municipal  securities. 
Accumulating  Foreign  Accounts. — Still  another  power 
in  the  hands  of  the  reserve  bank  is  that  of  creating  foreign 
accounts  against  which  exchange  may  be  sold  whenever 
necessary.  Reserve  banks,  whenever  they  have  available 
funds,  may  make  these  investments  in  the  foreign  markets, 
holding  the  bills  until  maturity,  or  discounting  them  if 
they  prefer.  These  accumulations  abroad  will  be  available 
for  use  later  in  time  of  need.  Some  of  the  reserve  banks,  for 
example  one  in  New  Orleans,  would  find  this  an  easy 
method  to  employ.  At  certain  seasons  of  the  year  large 
quantities  of  cotton  bills  can  be  purchased,  thus  furnishing 
a  considerable  supply  of  London  exchange.  These  bills 
could  be  discounted  at  once  in  London  and  drafts  sold 
against  the  proceeds.  If  the  funds  are  not  needed  in  the 
United  States  immediately,  the  bills  may  be  held  until  matu- 
rity and,  if  advisable,  even  reinvested  in  the  market  until 
wanted  at  home.  The  open  discount  market  in  Europe 
makes  easy  the  purchase  and  sale  of  such  bills.  This  intro- 
duces the  reserve  banks  into  the  banking  field  as  competitors, 
to  a  slight  extent,  with  the  foreign  exchange  houses,  and 
raises  the  question  of  their  ability  to  compete  successfully. 
It  is,  of  course,  dependent  upon  whether  or  not  they  will 
be  in  a  position  to  buy  and  sell  on  better  terms.  It  is  useless 
to  hazard  an  opinion  on  such  a  point,  but  it  is  well  to 
remember  that  the  present  foreign  exchange  houses  have 
large  resources  and  are  firmly  established  both  i!i  the  United 
States  and  with  their  foreign  connections. 


18!2      OPERATION  OF  THE  NEW  BANK  ACT 

Suspending  Reserve  Requirements. — An  extreme 
method  that  may  never  be  employed,  but  will  be  at  hand 
if  needed,  is  the  power  of  the  Federal  Reserve  Board  to  sus- 
pend, subject  to  stipulations,  any  and  every  reserve  require- 
ment in  the  Act.  This  covers  the  reserves  of  the  reserve 
banks  and  the  reserves  of  members.  A  graduated  tax  must 
be  imposed  on  such  deficiencies  as  are  allowed,  and  the 
amount  of  the  tax  on  the  deficiency  in  the  gold  reserve  be- 
hind the  reserve  notes  is  specified.  Such  an  authorization 
is  intended  for  use  only  in  extreme  emergencies  and  may 
be  compared  with  the  practice  of  the  Bank  of  England  on  a 
few  occasions  in  breaking  the  Bank  Act. 

Cooperation  among  Reserve  Banks. — We  have  spoken 
throughout  as  if  each  reserve  bank  was  the  only  one  in  the 
country.  There  may  be  as  many  as  twelve,  and  upon  some 
of  them  the  drains  for  gold  will  be  heavier  than  upon  others. 
The  one  located  in  New  York,  which  is  our  great  import  and 
export  center,  will  doubtless  feel  the  demand  more  than 
others  and  should  fortify  itself  with  care  against  with- 
drawals. A  bank  located  at  an  interior  point  would  ordi- 
narily find  the  pressure  less  strong.  In  case  any  difficulty 
should  appear  in  a  given  district,  the  mere  fact  that  its 
organization  is  distinct  from  that  of  the  other  districts  will 
tend  to  localize  the  trouble.  If  it  becomes  too  intense,  the 
reserve  bank  of  that  district  may  ask  for  help  from  one  of 
the  other  reserve  banks,  and  the  Federal  Reserve  Board  may 
permit  or  even  require  such  help  to  be  given.  The  method 
will  be  through  the  second  reserve  bank  rediscounting  some 
of  the  paper  held  by  the  first.  This  compulsion  by  the 
Federal  Reserve  Board  may  be  exercised  only  upon  the  vote 
of  at  least  five  of  its  members,  and  the  rediscount  is  to  be 
at  a  rate  fixed  by  the  board. 

Effectiveness  of  the  Available  Methods. — TVill  these 
means  of  controlling  the  gold  supply  be  effective?  Our 
investigations  show  that  the  Act  legalizes  the  use  of  nearly 
all  the  important  methods  employed  abroad.  Their  effec- 
tiveness, hoAvever,  will  depend  on  exactly  the  same  consid- 
erations as  will  the  success  of  other  parts  of  the  law.    I\Iem- 


CONTROL  OF  THE  GOLD  SUPPLY  183 

ber  banks  will  not  always  find  it  profitable  to  use  such 
checks  as  are  at  their  disposal  to  conserve  the  gold  supply, 
for  at  times  more  will  be  gained  by  them  individually 
through  a  different  policy.  Since  they  manage  the  reserve 
banks  through  their  election  of  two-thirds  of  the  directors, 
there  may  be  fatal  delays  in  using  the  forces  at  hand. 

Here,  as  elsewhere,  safety  lies  in  the  good  judgment  and 
unselfishness  of  the  bankers,  especially  of  those  on  the  direc- 
torates of  the  reserve  banks,  and  in  the  judgment,  firmness 
and  tact  of  the  Federal  Reserve  Board.  The  chief  weakness 
is  in  the  possibility  of  friction,  which  may  develop  if  one 
resei've  bank  is  compelled  to  rediscount  for  another.  IMuch 
has  been  made  of  this  from  time  to  time  in  the  public  press, 
and  considerable  attention  was  given  to  it  in  the  hearings 
before  the  Congressional  committees.  It  seems  probable 
that  the  difficulty  has  been  exaggerated.  The  banks  of  cer- 
tain sections  of  the  country  already  borrow  heavily  from 
other  sections,  and  little  is  thought  of  it.  New  York  does 
not  trouble  itself  over  the  fact  that  relief  is  given  to  the 
South  each  fall  when  that  relief  is  needed.  There  will  be 
no  more  cause  for  such  sectional  jealousy  in  the  future  than 
in  the  past,  and  just  so  long  as  each  of  the  reserve  banks 
is  conducted  with  conservatism,  there  should  be  no  legiti- 
mate reason  for  the  refusal  of  any  other  to  give  aid  whenever 
it  is  needed.  Moreover,  the  discount  rate  imposed  by  the 
Federal  Reserve  Board  at  such  times  will  be  high  enough  to 
make  the  giving  of  assistance  profitable. 

On  the  whole,  our  foreign  exchange  situation  will  be 
strengthened.  We  have  been  in  the  past  almost  helpless 
against  withdrawals  of  gold.  In  fact,  it  has  sometimes 
been  said  that  our  market  is  the  only  free  market  for  gold 
in  the  world.  It  certainly  has  been  one  from  which  gold 
could  very  readily  be  withdrawn  when  other  countries 
desire  it,  but  not  one  to  which  gold  could  be  attracted  as 
readily  as  to  most  other  large  markets.  Under  our  new 
law  there  should  bo  n  chanfre  for  the  bettor. 


CHAPTER  XIX 

Government  Deposits  and  the  Relations  of  the  Reserve 
Banks  to  the  Government 

Reasons  for  the  Independent  Treasury  System. — A 
very  important  feature  of  the  Federal  Reserve  Act  concerns 
the  relations  of  the  regional  banks  and  the  Federal  Reserve 
Board  with  the  United  States  government.  For  many  years 
the  banks  of  this  country  have  conducted  a  persistent  agi- 
tation for  the  abolition  of  the  Independent  Treasuiy  sys- 
tem. It  has  been  their  contention  that  the  Independent 
Treasury  was  an  archaic  and  inefficient  system  of  adminis- 
tering the  finances  of  the  nation ;  that  it  worked  serious 
hardship  upon  the  banks  and  the  business  of  the  country, 
and  that  any  system  of  reform  should  include  its  abolition. 

The  Independent  Treasury  was  established  in  1846. 
Upon  the  expiration  of  the  charter  of  the  Second  Bank  of 
the  United  States,  the  government  adopted  a  plan  of  de- 
positing its  funds  in  certain  State  banks  selected  by  the 
Secretary  of  the  Treasury.  With  the  collapse  of  the  State 
banks,  following  the  era  of  wildcat  banking,  the  people 
realized  the  danger  to  which  the  government's  funds  were 
subjected,  and  Congress  established  the  Independent  Treas- 
ury. The  Treasury  is,  in  realitj'-,  a  central  bank  of  deposit, 
with  branches,  run  by  the  government,  in  which  the  gov- 
ernment is  the  only  depositor,  and  from  which  there  are  no 
borrowers.  The  central  oflfice  of  the  Treasury  is  situated  in 
Washington,  while  there  are  ten  subtreasuries  or  branches 
scattered  among  the  various  large  cities  of  the  countiy. 
The  most  important  subtreasury,  from  the  stand-point  of 
the  volume  of  business  handled,  is  located  in  New  York  City. 

Until  a  few  years  ago  the  entire  receipts  of  the  govern- 
ment were  deposited  in  the  Treasury  or  in  its  branches,  and 
the  disbursements  were  made  by  warrants  drawn  by  the 
Treasury  Department  upon  the  balances  held  in  the  Treas- 
184 


GOVERNMENT  DEPOSITS  185 

ury.  These  warrants  were  deposited  in  the  banks  and  were 
collected  by  them  in  accordance  with  the  regulations  then 
prevailing.  The  subtreasury  in  New  York  City  has  for 
many  years  been  a  member  of  the  New  York  Clearing  House, 
and  warrants  drawn  upon  it  and  certified  checks  which  it 
receives  in  payment  of  customs  dues,  etc.,  are  cleared 
through  the  clearing  house  in  the  same  way  as  though  the 
subtreasury  was  one  of  the  banks  of  New  York  City.  The 
United  States  is  the  only  large  nation  in  the  world  which 
has  a  treasury  system  of  this  sort,  and  this  fact  has  been 
made  much  of  in  the  agitation  for  its  abolition. 

Difficulties  Arising  from  the  Treasury  System. — There 
is  no  room  for  dispute  that  many  features  of  the  Inde- 
pendent Treasury  have,  in  the  past,  been  the  source  of  seri- 
ous difficulties.  However,  we  must  recognize  that  within 
the  last  decade,  and  particularly  within  the  last  two  or  three 
years,  most  of  the  glaring  defects  have  been  eliminated 
through  a  liberalization  in  methods,  involving,  in  brief, 
a  deposit  of  a  very  considerable  amount  of  the  government 's 
money  in  national  banks  rather  than  carrying  it  locked  up 
in  the  vaults  of  the  Treasurj'-,  through  more  liberal  adminis- 
trative regulations  by  which  payments  to  the  Treasury 
could  be  made  with  certified  checks,  and  through  facilitating 
in  other  ways  the  transactions  of  business  men  with  the 
Treasury  Department. 

Treasury  System  to  be  Preserved. — Inasmuch  as  the 
Treasury  system  is  to  be  preserved,  it  is  necessary^  to  review 
briefly  the  defects  which  are  alleged  to  exist  in  it.  The 
gravest  objection  which  has  been  raised  is  that  it  is  a  device 
which  locks  up  a  great  deal  of  money,  taking  it  out  of  the 
channels  of  trade,  making  it  unavailable  to  conduct  the 
business  of  the  country,  and  having  the  same  effect  on  the 
banking  situation  as  would  the  hoarding  of  an  equal  amount 
of  money  by  thousands  of  short-sighted  individuals.  This 
money  is  sequestered  in  the  Treasur>%  not  because  of  any 
hostile  designs  upon  the  part  of  the  Secretary'  of  the  Treas- 
ury, of  the  administration  in  power,  or  of  Congress,  but  as 
the  result  of  the  fiscal  operations  of  the  government.    The 


186       OPERATION  OF  THE  NEW  BANK  ACT 

government's  finances  are,  in  their  general  outlines,  very 
similar  to  those  of  a  business  firm  or  of  an  individual.  There 
must  of  necessity  be  some  relation  between  the  income  and 
the  expenditures,  and  while  the  expenditures  are,  to  a  large 
degree,  controlled  by  the  revenues  of  the  government,  yet 
it  is  impossible,  even  though  Congress  should  endeavor  to 
do  so,  to  effect  a  nice  adjustment  so  that  the  net  balance 
on  hand  would  always  be  about  the  same  amount.  From 
time  to  time,  because  of  political  exigencies,  changes  are 
made  in  the  various  forms  of  taxation,  such  as  changes  in 
tariff  duties,  internal  revenue  duties,  the  establishment  of 
an  excise  or  corporation  tax,  or  an  income  tax.  The  Treas- 
ury experts  are  called  upon  by  Congress  to  furnish  infor- 
mation concerning  the  probable  revenue  which  will  be  de- 
rived from  this  proposed  taxation ;  but  no  matter  how 
careful  may  be  their  investigation,  it  is  impossible  to  foretell 
accurately  the  receipts  which  will  be  forthcoming.  In 
addition,  a  large  proportion  of  the  government's  income  is 
dependent  upon  the  activity  of  trade  and  business.  When 
trade  conditions  are  brisk,  importations  are  large,  and  the 
customs  duties  consequently  heavy;  and  the  same  is  true, 
though  to  a  much  less  extent,  of  a  large  proportion  of  the 
internal  revenue  taxes.  Therefore,  the  revenues  of  the 
government  fluctuate  considerably  from  year  to  year,  even 
upon  the  same  basis  of  taxation.  Under  these  conditions, 
and  because  the  end  and  aim  of  the  government  is  not  to 
spend  all  of  the  money  which  is  derived  by  taxation,  it  fol- 
lows that,  at  times  when  the  receipts  are  unusually  large, 
the  balance  in  the  Treasury  will  run  up.  On  the  other  hand, 
when  revenues  are  slim,  as  during  the  first  few  years  of  the 
Taft  administration,  the  Treasury  balances  will  decrease 
because  Congress  is  spending  more  money  than  the  govern- 
ment is  receiving.  It  happens  that  these  conditions  run 
counter  to  the  desires  and  w'ishes  of  business.  The  era  of 
large  receipts  is  the  era  of  business  prosperity,  in  which 
the  banks  are  subjected  to  a  hea\y  strain  in  financing  the 
increased  business  transactions  of  the  country.  The  large 
balances  which  are  created  in  the  Treasury,  it  is  argued. 


GOVERNMENT  DEPOSITS  187 

represent  money  drawn  out  of  the  banks  at  the  time  when 
they  most  need  it  and  when  its  withdrawal  weakens  the 
whole  fabric  of  the  banking  situation,  bringing  about  a 
condition  which  makes  a  collapse  possible  at  any  time. 

Hoarding  of  Money  through  Treasury  Operations. — 
On  the  other  hand,  the  period  in  which  the  government's 
income  is  reduced  is,  unfortunately,  a  period  of  depression ; 
and  the  transferring  of  a  considerable  amount  of  money  to 
the  banks  is,  at  such  times,  a  curse  because  it  adds  to  the 
idle  funds  then  on  hand  in  the  banks  for  which  no  safe  em- 
ployment can  be  found,  owing  to  the  passivity  of  business 
conditions,  makes  money  a  drug,  encourages  speculation  and 
creates  unhealthy  conditions  which  tend  still  further  to 
prolong  the  depression. 

This  theory  is  exceedingly  plausible,  and  is,  to  some 
degree,  based  on  fact.  Nevertheless,  an  examination  of  the 
statistics  will  show  that  the  Treasuiy  balances  do  not  fluc- 
tuate to  as  large  an  extent  as  would  be  indicated  by  the 
above  argument.  The  following  figures,  taken  from  the 
report  of  the  Comptroller  of  the  Ciirrency,  show  the  relative 
amount  of  money  in  the  Treasury,  controlled  by  banks,  and 
in  circulation  during  the  period  from  1902  to  1912 : 

Coin  and  other 

Coin  and  other  money  Coin  and  other  money  money  not  in 

Year  ended                  in  Treasury  as  in  reporting  Treasury  or 

June  30.                            assets.  banks.  banks. 

Per  cent.  Per  cent.  Per  cent. 

1902                           12.24  32.G9  55.07 

190;j                            11.80  31.59  50.01 

1904  10.14  35.00  54.80 

1905  10.24  34.27  55.49 

1906  10.86  32.92  56.22 

1907  11.00  35.51  53.49 

1908  10.08  40.34  49.58 

1909  8.81  42.40  48.78 

1910  9.27  41.37  49.36 

1911  9.61  43.46  46.93 

1912  9.98  42.86  47.16 

It  will  be  seen,  as  a  matter  of  fact,  that  the  Treasury 
balances  steadily  decreased  throughout  the  entire  period 
from  1901  to  1907,  which  was  a  time  of  very  great  business 
activity ;  whereas,  under  the  theory,  there  should  have  been 


188       OPERATION  OF  THE  NEW  BANK  ACT 

a  veiy  considerable  increase.  At  the  same  time,  it  will  be 
observed  that  the  amount  of  money  in  the  control  of  the 
banks  considerably  increased,  particularly  in  the  years 
immediately  preceding  the  panic  of  1907,  Finally  the 
Comptroller's  statistics  indicate  that  the  money  that  was 
presumably  in  circulation  among  the  people  increased  up 
to  the  time  of  the  panic  in  1907,  and  that  this  was  a  more 
serious  problem  than  the  absorption  of  money  by  the 
Treasury, 

Correspondence  of  Treasury  Receipts  and  Disburse- 
ments.— It  is  not  sufficient,  however,  to  be  content  with 
an  examination  of  the  average  balances  in  the  Treasury 
by  years,  for  this  is  of  little  significance  other  than  as  show- 
ing the  general  situation  which  the  Treasury  problem  intro- 
duces over  a  long  period  of  time.  The  real  criticism  against 
the  Treasury  is  that  it  causes  the  tying  up  of  money,  not 
over  a  series  of  years,  but  during  the  months  in  which  the 
banking  system  of  the  country  most  needs  it.  This  con- 
dition is  the  result  of  the  lack  of  correspondence  between 
government  receipts  and  disbursements. 

During  the  first  four  months  of  the  year  the  receipts  are 
less  than  in  any  other  period.  During  the  month  of  May, 
the  receipts  sharply  increase,  reaching  their  maximum  about 
the  first  of  June,  and  continuing  at  a  very  high  rate  over 
that  month.  In  July  the  income  falls  off,  reaching  by  the 
end  of  the  month  a  point  a  little  above  that  which  prevailed 
in  April,  after  which  it  gradually  increases  during  August 
and  September,  About  October  first  the  tide  turns  and  the 
receipts  fall  off  sharply  during  that  month,  while  during 
December  the  revenue  again  increases.  As  contrasted  with 
this  the  government  expenditures  change  only  in  a  general 
way.  Beginning  with  large  disbursements  at  the  first  of  the 
year,  they  decline  over  the  month  of  Januar^',  are  practically 
stationary  in  February,  increase  slightly  in  INIarch,  only 
to  fall  off  again  in  April,  a  decrease  which  is  followed  by 
a  much  sharper  decline  in  May,  the  low  point  for  the  year 
being  reached  at  the  end  of  the  month.  During  the  month 
of  June  there  is  a  very  sharp  increase,  which  reaches  the 
maximum  for  the  year  on  July  1,     During  July  there  is 


GOVERNMENT  DEPOSITS  189 

a  correspondingly  sharp  decline,  followed  by  a  more  mod- 
erate reduction  in  August.  The  tide  turns  upward  again 
in  September  and  reaches  the  maximum  on  the  first  of 
October,  from  which  there  is  a  gradual  decline  during  the 
balance  of  the  year. 

The  following  table  shows  the  receipts  and  disbursements 
of  the  government  for  each  month  during  the  fiscal  year  of 
1912-13,  excluding  Panama  canal  financing.  The  year  is 
fairly  typical: 

(000  omitted) 

Ordinary 
disbursements, 
Ordinary  exclusive  of 

receipts,  postal,  principal 

exclusive  of  debt,  ana 

Months  of  postal.  premium. 

1012— July    $59,536  $00,279 

August     60,205  63,315 

September     55,682  58,446 

October     64,469  60,606 

November     59,069  54,241 

December     55,821  59,417 

1913_january    60,542  53,605 

February     54,803  52.839 

March     56,720  51,478 

April     53,452  57,106 

May      55,370  57,957 

June     88,438  53,476 

Total  for   12  months    $724,111  $682,770 

Exaggeration  of  Treasury  Evils. — It  should  be  stated 
that  whatever  embarrassment  exists  because  of  this  con- 
dition, and  which  as  a  matter  of  fact  has  been  grossly  exag- 
gerated, is  found  almost  entirely  in  New  York  City. 

However,  in  order  to  reduce  as  much  as  possible  the 
objections  raised  by  the  bankers  and  to  prevent  money 
being  taken  out  of  circulation  and  buried  in  the  Treasury, 
where  it  would  be  of  no  service  to  the  country,  the  Secretary 
of  the  Treasury,  on  January  9,  1913,  issued  the  following 
order,  Avhich  inaugurated  a  radical  change  in  the  manner 
of  handling  and  disbursing  the  public  funds.  The  objects 
to  be  accomplished  were  announced  in  the  order  as  follows: 

**  For  the  purpose  of  bringing  the  ordinary  fiscal  trans- 
actions of  the  Federal  Government  more  nearly  into  har- 
mony with  present  business  practices,  it  has  been  determined 


190       OPERATION  OF  THE  NEW  BANK  ACT 

that  the  daily  receipts  of  the  govermnent  shall  be  placed 
with  the  national  bank  depositaries  to  the  credit  of  the 
Treasurer  of  the  United  States.  Disbursements  will  be  made 
by  warrant  or  check  drawn  on  the  Treasurer,  but  payable 
by  national  bank  depositaries,  as  well  as  by  the  Treasuiy 
and  subtreasuries. " 

Secretary  McAdoo,  in  his  report  for  the  fiscal  year  end- 
ing June  30,  1913,  in  speaking  of  this,  stated  that  while 
it  had  caused  some  embarrassment  "the  difficulties  at  first 
encountered  are  disappearing,  and  the  system  appears  to 
respond  to  the  public  requirements,  and  to  be  accomplish- 
ing the  purposes  for  which  it  was  devised." 

Division  of  Treasury  Funds. — The  Treasury  funds  may 
be  said  to  consist  of  two  main  parts,  the  one  known  as  the 
gold  reserve  and  the  currency  trust  fund,  having  to  do  with 
the  keeping  of  a  store  of  gold  for  the  purpose  of  supporting 
the  value  of  paper  money  and  silver  dollars  in  circulation ; 
and  the  other,  known  as  the  general  fund,  consisting  of 
the  available  balance  of  the  Treasury,  representing  funds 
available  for  the  pa^Tnent  of  debts  of  the  government.  The 
Treasury  Department  issues  daily  a  statement  showing  in 
detail  the  status  of  both  of  these  departments.  The  form 
of  this  statement  is  shown  by  the  following  reproduction 
of  the  statement  as  of  January  3,  1914 : 

DAILY  STATEMENT  OF  THE  UNITED  STATES  TREASURY 
at  close  of  business  january  3,  1914 
Cash  Assets  and  Liabilities 
general  fund 
Cash:  Assets 

In  Treasury  Offices — 

Gold    coin    $21,375,295.06 

Gold    certificates    88,140,510.00 

Standard    silver    dollars    1,878.473.00 

Silver   certificates    13.860.852.00 

United  States  notes    6,954,720.00 

Treasury  notes   of   1890    5.452.00 

Certified  checks  on  banks    899,007.10 

National-bank    notes     36,011,439.10 

Note.— This  includes  $33,036,259.10  which  the  Treas- 
ury has  redeemed  and  for  which  it  will  receive  payment 
from  national  banks. 


GOVERNMENT  DEPOSITS  191 

Subsidiary   silver  coin    $14,508,605.55 

Fractional   currency    348.77 

Minor   coin    1,145,639.78 

Silver      bullion       (available      for      subsidiary 

coinage)      1,518,389.43 

$18G,;j.58,7;5i.7'J 

In  National-banic  Depositaries — 

To    credit   of    Treasurer    United    States 84,544,226.87 

To  credit  of  postmasters,  judicial  ollicers,  etc.  .  7,100,038.11 

hi  Treasury  I'liilippincs — 

To  credit  of  Treasurer  United  States 3,006,590.21 

To  credit  of  disbursing  ollicers 4,055.308.09 

Total     $285,064,8!)5.07 

Liabilities 
Current  Liabiuties  : 
In  Treasury  Offices — 

Disbursing   ollicers'    balances    $69,315,667.67 

Outstanding  warrants 1,144,179.05 

Outstanding  Treasurer's  checks   (>.26J.(iS4.27 

Post  Oflice  Department  balances   9,525,336.49 

Postal   Savings   balances    1,491,621.27 

Judicial    officers'    balances,    etc 8,623,747.90 

National-bank   notes:    Kedeniptiuii   fund*    ....  17,Ot):}.078.r)0 

National-bank  5  per  cent  fund 31.270.7.")."!.(il 

Assets    of    failed    national    banks 14,020,161.93 

Coupons  and   interest  checks    3,309.074.02 

Miscellaneous    (exchanges,  etc.)     10,809,564.50 

Total $172,835,860.21 

Subtract:  Checks  not  cleared 10,827.851 .67 

$162,008,017.54 

In  National  Depositaries — 

Judicial    officers'    balances,    etc 7,100,038.11 

Outstanding   warrants    223,529.98 

In  Treasury  Philippines — 

Disbursing  officers'  balances   4,055,308.00 

Outstanding   warrants    1,677,014.09 

$l7-"),nf,:i.!)07.8i 

Net   balance    in   general   fund    110,000,987.20 

Total     $285,064,895.07 

♦The  act  of  July  14,  1890,  provides  that  deposits  made  by  national  banks  to 
redeem  circiilntine  notes  shall  he  covered  into  the  Treasury  as  miscellaneous  receipts 
and  that  the  Treasury  shall  redeem  from  the  general  cash  the  circulating  notes  which 
come  into  its  possession  subject  to  redemption. 


192       OPERATION  OF  THE  NEW  BANK  ACT 

THE     CUBBENCY    TBUST    FUNDS,     THE    GENEBAL    FUND,    AND     THE    GOLD 
EESEBVE    FUND 

Assets 

CUEBENCY    TbUST    FuNDS: 

Gold   coin    $865,751,495.00 

Gold    bullion     254,614,474,00 

Total  gold  $1,120,365,909.00 

Silver    dollars    489,620,000.00 

Silver   dollars   of    1890    2,553,000.00 

Total  currency  trust  funds  $1,612,538,969.00 

Genebal  Fund: 

Total  cash  assets,  as  above 285,064,895.07 

Gold  Resebve  Fund: 

Gold   coin    100,000,000.00 

Gold  bullion    50,000,000.00 

Grand  total  cash  assets  in  Treasury $2,047,603,864.07 


Liabilities 

Outstanding  Cebtificates  : 

Gold  certificates  outstanding   $1,120,365,969.00 

Silver   certificates   outstanding    489,620,000.00 

Treasury  notes  outstanding   2,553,000.00 

Total  outstanding  certificates $1,612,538,969.00 

General  Fund,  Liabilities  and  Balance  : 

Total  liabilities,  as  above    175,063,907.81 

Balance    in    general    fund,    as 

above    $110,000,987.26 

Gold  Reserve  150,000,000.00 

Note. — Reserved  against  $346,681,- 
016  of  U.  S.  notes  and  $2,553,000  of 
Treasury  notes  of  1890. 

Total    net    balances    260,000,987.26 

$2,047,603,864.07 

The  General  Fund. — The  general  fund  consists  of  two 
parts :  first,  the  cash  in  the  possession  of  the  United  States 
Treasury  or  in  the  various  subtreasuries,  and  second,  de- 
posits of  the  Treasurer  in  the  national  banks  and  in  the 


GOVERNMENT  DEPOSITS  193 

Treasury  of  the  Philipijiiie  Islands.  Upon  the  day  in  ques- 
tion there  were  some  $180,000,000  of  cash  on  hand  and  some 
$99,000,000  of  funds  on  deposit  to  the  credit  of  the  United 
States,  a  great  majority  of  which  was  in  the  custody  of  the 
national  banks,  which  had  been  selected  by  the  government 
as  depositaries. 

One  feature  of  the  general  fund  account  deserves  sepa- 
rate treatment.  The  National  Bank  Act  requires  each 
national  bank  having  circulation  outstanding  to  keep  on 
deposit  with  the  United  States  Treasury  a  redemption  fund, 
which  shall  at  all  times  equal  in  amount  at  least  five  per 
cent  of  the  then  outstanding  circulation  of  the  bank.  The 
redemption  fund  is  intended  to  provide  the  Treasury  with 
funds  necessaiy  to  redeem  the  national  bank  notes  when 
they  are  presented  for  retirement.  As  a  matter  of  fact, 
for  many  years  the  fund  has  been  continually  overdrawn, 
the  government  having  advanced,  in  the  year  1911-12,  a 
monthly  average  of  about  $12,500,000  from  the  general 
fund  of  the  Treasury,  for  the  purpose  of  redeeming  the 
notes  of  national  banks  returned  for  redemption,  over  and 
above  the  amount  of  money  on  deposit  by  the  national  banks 
of  the  country  for  this  purpose. 

In  the  chapter  on  "Note  Issues"  the  reasons  for  the  re- 
markably large  volume  of  national  bank  notes  which  are 
presented  for  redemption  are  considered  in  detail.  It  is 
sufficient  to  say  here  that  the  large  overdrafts  in  connection 
with  the  five  per  cent  redemption  fund  are  due  to  the  fact 
that  nearly  ninety  per  cent  of  the  national  bank  notes  go 
through  the  redemption  agency  each  year. 

Under  the  provisions  of  the  National  Bank  Act  the 
amount  of  money  to  the  credit  of  a  bank  for  the  redemption 
fund  account  could  be  counted  by  the  bank  as  a  part  of  its 
cash  reserve.  Since  the  signing  of  the  Federal  Reserve  xVct 
by  the  President,  on  December  23,  1913,  it  is  impossible  for 
a  bank  in  calculating  its  reserve  to  include  the  five  per  cent 
redemption  fund.  The  clause  of  the  Act  covering  this  point 
reads  as  follows:  "So  much  of  Sections  2  and  3  of  the  Act 
of  June  twentieth,  eighteen  hundred  and  seventy-four,  en- 

19 


194       OPERATION  OF  THE  NEW  BANK  ACT 

titled  'An  Act  fixing  the  amount  of  United  States  notes, 
providing  for  a  redistribution  of  the  national  bank  currency, 
and  for  other  purposes, '  as  provides  that  the  fund  deposited 
by  any  national  banking  association  with  the  Treasurer  of 
the  United  States  for  the  redemption  of  its  notes  shall 
be  counted  as  a  part  of  its  lawful  reserve  as  provided  in  the 
Act  aforesaid,  is  hereby  repealed.  And  from  and  after 
the  passage  of  this  Act  such  fund  of  five  per  centum  shall 
in  no  case  be  counted  by  any  national  banking  association 
as  a  part  of  its  lawful  reserve." 

The  Trust  Funds. — In  addition  to  the  general  fund 
there  exist  two  other  important  funds:  the  currency  trust 
fund  and  the  gold  reserve  fund.  The  currency  trust  fund 
is,  as  its  name  implies,  a  trust  fund  held  by  the  Treasurer  to 
meet  the  requirements  of  the  law  concerning  certain  forms 
of  our  paper  money.  A  very  large  proportion  of  the  gold 
in  use  in  the  banking  system  in  this  country  is  used  in  the 
form  of  gold  certificates.  These  gold  certificates  are  in 
reality  nothing  but  warehouse  receipts,  issued  by  the  United 
States  Government,  certifying  to  the  fact  that  the  govern- 
ment holds  on  deposit  in  the  Treasury  a  certain  number  of 
dollars  in  gold,  which  will  be  paid  to  the  bearer  upon 
demand. 

On  January  3,  1914,  the  first  portion  of  the  currency 
trust  fund  consisted  of  gold  coin  and  gold  bullion  aggregat- 
ing an  amount  of  $1,120,000,000,  against  which  there  is  out- 
standing an  identical  amount  in  gold  certificates.  The  sec- 
ond portion  of  the  currency  trust  fund  consisted  of  the 
deposits  of  silver  dollars  against  the  silver  certificates  and 
Treasury  notes  outstanding.  These  deposits  of  gold  and 
silver  must  be  held  intact,  separate  and  apart  from  the 
other  funds  in  the  Treasury,  for  the  purpose  of  meeting 
the  requirements  of  the  law  and  keeping  the  pledge  of  the 
United  States  written  upon  the  paper  issued  and  out- 
standing. 

The  Gold  Reserve. — The  gold  reserve  fund  consists  of 
$150,000,000,  of  which  $100,000,000  is  gold  coin  and  $50,- 
000,000  is  gold  bullion,  although  the  proportion  of  bullion 


GOVERNMENT  DEPOSITS  195 

in  the  latter  amount  is  discretionary  with  the  Treasury- 
Department.  The  $150,000,000  gold  reserve  was  established 
by  the  Act  of  Congress  of  March  14,  1900,  entitled  "An  Act 
to  define  and  fix  the  standard  of  value  and  maintain  the 
parity  of  all  forms  of  money  issued  or  coined  by  the  United 
States,  to  refund  the  public  debt,  and  for  other  purposes." 
This  is  popularly  referred  to  as  the  Gold  Standard  Act. 
It  provides  that  all  legal  tender  notes  shall  be  redeemed  for 
gold  coin  on  demand,  and  that  the  Treasurer  shall  keep  a 
reserve  at  all  times  equal  to  at  least  $150,000,000,  to  consist 
of  gold  coin  and  bullion,  for  the  purpose  of  redeeming  such 
notes  as  may  be  presented  and  for  no  other  purpose.  Notes 
which  are  redeemed  out  of  this  fund  may  be  reissued  only 
in  exchange  for  gold.  If  the  fund  at  any  time  falls  below 
$100,000,000,  the  Secretary  of  the  Treasury  is  directed  to 
restore  it  to  the  maximum  siun  of  $150,000,000  by  the  sale 
of  bonds,  the  proceeds  from  the  sale  of  such  bonds  not  to  be 
used,  under  any  circumstance,  to  meet  deficiencies  in  current 
funds.  The  provision  that  notes  shall  be  reissued  only  in 
exchange  for  gold  has  never  worked  as  a  check  against  the 
reissuing  of  the  legal  tender  notes;  for  it  is  the  practice, 
when  these  notes  are  presented  for  redemption  through  the 
gold  reserve  fund,  for  the  Treasury  Department  to  place 
them  among  their  assets  in  the  general  fund,  taking  there- 
from an  amount  of  gold  coin  or  gold  certificates  equal  in 
amount  to  the  legal  tender  notes  so  transferred.  Thus  the 
letter  of  the  law  is  complied  with,  if  not  the  spirit. 

Gold  Standard  Reaffirmed. — In  order  that  no  doubt 
might  arise  in  the  mind  of  any  one  concerning  the  effect 
which  the  Federal  Reserve  Act  had  upon  the  Act  of  ^farch 
14,  1900,  the  following  provision  was  inserted  in  the  new 
law:  "Nothing  in  this  Act  contained  shall  be  construed  to 
repeal  the  parity  provision  or  provisions  contained  in  an 
Act  approved  March  fourteenth,  nineteen  hundred  •  •  • 
and  the  Secretary  of  the  Treasury^  may,  for  the  purpose  of 
maintaining  such  parity  and  to  strengthen  the  gold  reserve, 
borrow  gold  on  the  security  of  TTnited  States  bonds  author- 
ized by  Section  2  of  the  Act  last  referred  to,  or  for  one-year 


196       OPERATION  OF  THE  NEW  BANK  ACT 

gold  notes,  bearing  interest  at  a  rate  of  not  to  exceed  three 
per  centum  per  annum,  or  sell  the  same  if  necessary  to  obtain 
gold.  When  the  funds  of  the  Treasury  on  hand  justify,  he 
may  purchase  and  retire  such  outstanding  bonds  and  notes. ' ' 

The  gold  reserve  fund  supports  $346,681,016  of  United 
States  notes,  and  on  January  3, 1914,  $2,553,000  of  Treasury 
notes  of  1890.  While  there  has  been  from  time  to  time  some 
agitation  for  the  retirement  of  the  United  States  notes,  on 
the  ground  that  a  large  proportion  of  them  represent  noth- 
ing but  the  promise  of  the  United  States  to  pay  money  and 
might  cause  trouble  in  the  future,  yet  the  movement  has  not 
been  strong  enough  to  have  any  definite  results. 

The  Federal  Reserve  Act  will  make  possible  a  radical 
revision  of  the  methods  of  the  Treasury  Department  and  the 
position  of  the  Independent  Treasury  as  regards  the  banking 
system  of  the  country. 

Effect  of  Reserve  Act  on  Treasury  Methods. — Section 
15  of  the  Act  reads  as  follows:  "The  moneys  held  in  the 
general  fund  of  the  Treasury,  except  the  five  per  centum 
fund  for  the  redemption  of  outstanding  national  bank  notes 
and  the  funds  provided  in  this  Act  for  the  redemption  of 
Federal  reserve  notes  may,  upon  the  direction  of  the  Secre- 
tary of  the  Treasury,  be  deposited  in  Federal  reserve  banks, 
which  banks,  when  required  by  the  Secretary  of  the  Treas- 
ury, shall  act  as  fiscal  agents  of  the  United  States ;  and  the 
revenues  of  the  Government  or  any  part  thereof  may  be  de- 
posited in  such  banks,  and  disbursements  may  be  made  by 
checks  drawn  against  such  deposits. 

'*No  public  funds  of  the  Philippine  Islands,  or  of  the 
postal  savings,  or  any  government  funds,  shall  be  de- 
posited in  the  continental  United  States  in  any  bank  not 
belonging  to  the  system  established  by  this  Act :  Provided, 
however,  That  nothing  in  this  Act  shall  be  construed  to  deny 
the  right  of  the  Secretary  of  the  Treasury  to  use  member 
banks  as  depositaries." 

A  careful  analysis  of  this  section  brings  out  some  very 
important  matters.  In  the  firet  place,  the  five  per  cent 
redemption  fund  must,  under  all  circumstances,  remain  in 


GOVERNMENT  DEPOSITS  197 

the  vaults  of  the  Treasury  Department,  and  the  Secretary 
of  the  Treasury  is  required  to  deposit  the  public  funds  of  the 
Philippine  Islands  or  of  the  postal  savings,  or  any  govern- 
ment funds,  only  in  banks  in  the  continental  United  States, 
which  are  a  part  of  the  Federal  reserve  system.  The  Act 
does  not  prevent  the  Secretary  of  the  Treasury  continuing 
the  present  deposits  with  the  national  banks,  a  fact  which 
has  apparently  been  overlooked  by  many  bankers  in  discus- 
sing the  effect  which  the  new  law  will  have  upon  their 
affairs.  As  to  whether  the  Secretary  will  see  fit  to  transfer 
the  balances  in  the  member  banks  to  Federal  reserve  banks 
or  to  the  Treasury  we  will  leave  for  subsequent  discussion. 
It  is  singular  that  so  little  attention  was  given,  while  the 
bill  was  before  Congress  for  consideration,  to  the  very  large 
powers  conferred  upon  the  Secretarj'^  of  the  Treasury,  con- 
cerning the  place  in  which  government  funds  should  be  kept. 
Great  Power  of  Secretary  of  the  Treasury. — For  many 
years  criticism  has  been  leveled  against  the  policies  of  Secre- 
taries Shaw,  Cortelyou  and  IMcAdoo,  concerning  the  large 
amount  of  power  and  discretion  lodged  in  the  hands  of  these 
oflficials  over  the  vast  sums  of  money  representing  the  bal- 
ances in  the  general  fund  of  the  government,  which  if  wisely 
used  by  them  might  assist  business  in  the  country,  but 
which  if  improperly  used  would  bring  chaos  and  disorder 
throughout  the  entire  banking  world.  However  great  may 
have  been  the  power  of  the  Secretary  heretofore,  it  pales 
into  insignificance  as  contrasted  with  the  authority  vested  in 
him  by  virtue  of  the  Federal  Reserve  Act.  He  is  a  power 
supreme  and  unaccountable  to  any  authority  other  than 
the  President,  Congress,  and,  indirectly,  the  people  of 
the  nation.  In  order  that  there  may  be  no  doubt  as  to  the 
supreme  authority  of  the  Secretary  of  the  Treasury,  the 
following  provision  was  inserted  in  the  tenth  section : 
"Nothing  in  this  Act  contained  shall  be  construed  as  taking 
away  any  powers  heretofore  vested  by  law  in  the  Secretary 
of  the  Treasury  which  relate  to  the  supervision,  manage- 
ment, and  control  of  the  Treasury  Department  and  bureaus 
under  such  department,  and  wherever  any  power  vested  by 


198      OPERATION  OF  THE  NEW  BANK  ACT 

tliis  Act  in  the  Federal  Keserve  Board  or  the  Federal  reserve 
agent  appears  to  conHict  with  the  powers  of  the  Secretary  of 
the  Treasury,  such  powers  shall  be  exercised  subject  to  the 
supervision  and  control  of  the  Secretary." 

What  discretionary  powers  does  the  Secretary  possess? 
In  the  first  place,  it  is  optional  with  him  as  to  exactly  where 
he  shall  keep  the  balances  of  the  government.  He  has  three 
options.  First,  he  may  keep  them  in  the  vaults  of  the 
Treasury  Department,  as  was  done  for  so  many  years  by 
his  predecessors.  Second,  he  may  deposit  all  or  any  part 
of  the  general  fund  (not  including  the  redemption  fund), 
as  he  sees  fit,  with  the  member  banks.  Finally,  if  he  so 
elects,  he  may  transfer  the  balances  deposited  with  the 
member  banks  to  the  Federal  reserve  banks,  and  may,  at 
the  same  time,  transfer  the  entire  general  fund,  excluding 
the  five  per  cent  redemption  fund,  to  the  Federal  reserve 
banks.  Nor  does  his  authority  end  when  he  has  elected 
where  he  shall  carry  the  general  fund.  At  any  time  when 
he  sees  fit  he  can  transfer  the  money  from  one  depositary  to 
another,  and  there  is  no  authority  granted  by  the  Federal 
Reserve  Act  to  any  one  to  review  or  veto  such  transfer. 

Secretary  of  the  Treasury  and  the  Reserve  Bank.— The 
Secretary  of  the  Treasury  is  given  absolute  discretion  as 
to  how  much  money  shall  be  carried  in  any  Federal  reserve 
bank.  The  balance  which  he  carries  with  the  Federal  re- 
serve bank  is  not  determined  by  the  revenue  which  the  gov- 
ernment derives  from  taxation  in  the  region  presided  over 
by  that  institution,  nor  does  the  Secretary  have  to  make 
distribution  from  the  particular  reserve  bank  in  the  district 
where  the  government's  creditor  does  business.  This  great 
power  may  be  used  beneficently  or  foolishly,  depending 
upon  the  character,  ability  and  experience  of  each  particular 
Secretary  of  the  Treasury. 

As  an  illustration  of  the  way  in  which  it  can  be  used  to 
the  advantage  of  the  country,  let  us  see  how  the  Secretary 
can  cooperate,  if  he  so  desires,  in  getting  the  Federal  reserve 
banks  into  operation  with  the  smallest  amount  of  disturb- 
ance to  business.    At  the  present  time  he  has  at  his  disposal 


GOVERNMENT  DEPOSITS  199 

between  $150,000,000  and  $200,000,000  in  the  general  fund, 
which  he  may  transfer  in  whole  or  in  part  to  the  regional 
banks  for  the  purpose  of  increasing  their  assets  and  render- 
ing them  of  greater  value  to  the  business  community.  It 
is  anticipated  that  the  government  deposits  in  the  beginning 
will  be  almost  one-half  of  the  aggregate  resources  of  the 
Federal  reserve  banks.  If  the  Secretary  of  the  Treasury 
carefully  studies  the  needs  and  the  probable  demands  which 
will  be  put  on  the  Federal  reserve  banks,  he  can  so  deposit 
this  money  among  them  as  to  help  those  institutions  upon 
which  heavy  demands  will  be  made,  without  having  a  large 
amount  of  idle  money  in  the  vaults  of  the  other  reserve 
banks  upon  whioh  no  strain  will  be  placed,  thereby  saving 
them  from  any  temptation  toward  laxity. 

Importance  of  the  Calibre  of  the  Treasury  Head. — 
Again  the  Secretary  of  the  Treasury  can  to  a  large  degree 
save  the  Federal  Reserve  Board  from  the  criticism  which 
will  inevitably  arise  when  it  becomes  necessary  to  transfer 
funds  from  those  reserve  banks  having  a  large  surplus  to  the 
institutions  upon  which  undue  pressure  is  then  being 
brought,  by  the  simple  expedient  of  transferring  a  portion 
of  the  government  balances  from  the  reserve  banks  having 
a  surplus  to  those  in  need  of  aid.  These  two  illustrations 
indicate  the  great  power  for  good  which  the  Secretary  can 
exert. 

On  the  other  hand,  the  power  for  evil  is  fully  as  great; 
for  with  a  short-sighted,  partisan  or  provincial  Secretary 
the  entire  Federal  reserve  system  could  conceivably  be 
badly  disorganized.  lie  could  punish  a  section  whose  politi- 
cal tendencies  were  distasteful  to  him  by  transferring  the 
government  balances  from  that  reserve  bank  to  one  then  in 
favor  with  hun.  If  he  lost  his  head  in  times  of  panic  he 
could  wreck  the  entire  banking  system  of  the  country  by 
suddenly  demanding  the  refund  of  the  government  deposits 
by  all  of  the  reserve  banks.  It  is  not  intended  to  convey  the 
impression  that  the  Secretary  of  the  Treasury  will  ever 
be  so  foolish  as  to  do  anything  as  serious  as  has  been  indi- 


200       OPERATION  OF  THE  NEW  BANK  ACT 

cated.  After  all,  the  great  controlling  force  which  will 
regulate,  not  only  the  actions  of  the  Secretary  of  the  Treas- 
ury, but  also  the  policy  of  the  Federal  Reserve  Board  and 
of  the  member  banks,  is  intelligent  public  opinion  and  dis- 
passionate and  scientific  criticism  of  the  methods  currently 
pursued  in  the  management  of  the  banking  business  of  the 
country.  An  administration  which  would  allow  a  Secretary 
to  commit  any  of  the  serious  blunders  which  we  have  pre- 
viously sketched,  would  thereby  be  signing  the  political 
death  warrant  of  its  party. 

Should  the  Secretary  of  the  Treasury  Have  Such  Wide 
Latitude? — Why  should  the  Secretary  of  the  Treasury 
be  given  such  wide  latitude  in  the  administration  of  the 
Treasury  Department?  It  can  be  argued  with  considerable 
force  that  the  money  in  the  vaults  of  the  Treasury  is  useless 
to  support  and  accelerate  business,  and  that  it  is  an  economic 
loss  to  the  nation.  Would  it  not  be  better  to  require  the 
Secretary  of  the  Treasury,  as  was  provided  in  the  original 
draft  of  the  bill,  to  deposit  his  funds  with  the  regional  banks, 
leaving  to  the  Federal  Reserve  Board  the  responsibility  of 
dividing  this  money  among  these  banks  in  the  way  which 
would  bring  about  the  greatest  national  good  ?  This  course 
would  obviate  any  clash  of  authority  between  the  Federal 
Reserve  Board  and  the  Secretary  of  the  Treasury,  and  would 
enable  that  official  to  devote  his  entire  attention  to  the 
detailed  affairs  of  the  government,  thus  eliminating  a  great 
deal  of  uncertainty  and  removing  to  a  large  extent  the  possi- 
bility of  disturbance  in  the  Federal  Reserve  system  as  a 
result  of  politics.  On  the  other  hand,  it  can  be  argued  with 
equal  force  that  the  Secretary  of  the  Treasury  is  not  a  mere 
clerk,  but  the  responsible  executive  head  of  an  important 
department  of  the  government,  and  that,  if  he  is  fit  for  his 
great  oflRce,  he  can  be  trusted  to  have  discretion,  judgment 
and  ability. 

In  spite  of  all  the  care  which  has  been  taken  in  planning 
the  Federal  Reserve  sj^stem,  it  will  nevertheless  for  some 
years  be  an  experiment  to  entrust  the  general  fund  of  the 
government  to  the  Federal  reserve  banks.    To  give  the  Secre- 


GOVERNMENT  DEPOSITS  201 

tary  of  the  Treasury  no  control  whatever  over  this  money 
would  be  to  deprive  him  of  any  opportunity  to  protect  the 
interests  of  the  government,  in  case  any  bank  should  be  im- 
properly managed.  The  problems  which  must  be  solved 
by  the  directors  of  the  Federal  reserve  banks  are  different 
in  character  from  those  which  must  be  passed  upon  by 
the  directors  of  member  banking  institutions.  They  include 
many  questions  concerning  which  the  ordinary  bank  director 
is  ignorant.  They  involve  a  careful  study  of  the  entire 
banking  situation  in  this  country,  and  indeed  of  the  world, 
and  an  intimate  knowledge  of  many  questions  concerning 
which  a  large  proportion  of  these  directors  will,  at  the  begin- 
ning, have  very  little  information.  It  will  require  years  to 
educate  the  bankers  of  the  country  to  an  understanding  of 
the  larger  problems  of  banking  which  some  of  them  will  be 
called  upon  to  handle.  It  is  reasonable  to  presume  that  the 
Federal  reserve  banks  will  be  successful,  that  none  of  them 
will  become  insolvent,  and  that  no  depositor  will  lose  its 
money. 

Congress  was  not  of  a  temper  to  put  the  funds  of  the 
government  at  the  mercy  of  an  untried  group  of  bank  direc- 
tors, and  to  make  the  Secretary  of  the  Treasury  subservient 
to  thorn  in  the  handling  of  the  government's  money.  Time 
will  show  whether  the  judgment  of  Congress  was  sound. 
The  test  will  never  come  if  the  right  type  of  men  are 
appointed  to  the  office  of  Secretary  of  the  Treasury. 


CHAPTER  XX 

The  Reserve  Problem 

Our  Unscientific  Reserves. — The  most  serious  defect 
in  our  banking  system  is  the  unscientific  and  ineffective 
system  of  handling  the  reserves  of  the  twenty-five  thousand 
banks  in  the  country.  As  was  pointed  out  in  the  preliminary 
analysis,  the  reserves  of  this  country  are  decentralized  to 
a  greater  extent  than  in  any  other  countrv^  in  the  world, 
and  with  this  decentralization  has  gone  a  lack  of  elasticity 
which  makes  it  inevitable  that  our  banking  system  will 
break  down  whenever  it  is  subjected  to  a  severe  strain. 

The  consensus  of  opinion  among  the  bankers  who  ap- 
peared before  the  Congressional  committees  was  that  the 
most  vital  problem  in  the  Federal  Reserve  Act  was  the 
mobilization  of  the  reserves  of  the  banks  of  the  country. 
Mr.  Vanderlip,  in  his  testimony,  states  that  in  his  opinion 
"the  most  important  thing  that  we  need  is  the  mobilization 
of  reserves."  Mr.  A.  F.  Dawson,  President  of  the  First 
National  Bank  of  Davenport,  Iowa,  declared  that  in  his 
opinion  "this  question  of  reserves  is  really  the  ^^tal  ques- 
tion." Mr.  J.  F.  Scott,  Vice-President  of  the  First  National 
Bank  of  Houston,  Texas,  said  "the  main  object  of  creating 
those  Federal  reserve  banks  is  to  mobilize  the  present  scat- 
tered reserves  of  the  banks  of  the  countr^^  into  some  central 
points  where  they  can  be  utilized  in  a  legitimate  way,  in- 
stead of,  as  under  the  present  system,  locked  up  in  the 
several  thousand  separate  bankinsf  institutions  of  the  coun- 
try, serving  no  useful  purpose,  either  in  times  of  commercial 
prosperity  or  in  those  of  business  depression.  The  reserves 
thus  mobilized  "^vill  form  a  fund  as  a  basis  for  discounting 
commercial  obligations  of  credit  and  furnishing  against 
the  same,  through  the  subscribinsr  member  banks,  such  cir- 
culating notes  as  may  be  required  at  the  hands  of  com- 
merce," 
202 


THE  RESERVE  PROBLEM  203 

The  Present  Reserve  System  Explained. — If  we  are  to 

understand  the  radical  change  which  will  be  worked  by  the 
Federal  Reserve  Act  in  the  reserve  situation  in  this  coun- 
try it  is  necessary  to  examine  at  some  length  the  system 
heretofore  prevailing.  Under  the  National  Bank  Act  these 
banks  were  divided  into  three  groups  or  classes,  referred  to 
as  the  country  banks,  the  reserve  city  banks  and  the  central 
reserve  city  banks. 

There  are  three  central  reserve  cities:  New  York,  Chi- 
cago, and  St.  Louis.  Every  national  bank  in  these  cities  is 
a  central  reserve  city  bank.  The  reserve  cities  are  forty- 
seven  in  number  and  include  the  larger  cities  of  the  country. 
Every  bank  not  situated  in  any  one  of  the  three  central 
reserve  cities  or  the  forty-seven  reserve  cities  is  a  country 
bank.  This  last  term  includes  all  the  national  banks  of  the 
smaller  cities  in  the  country,  of  the  manufacturing  towns 
and  commuities  of  New  England  and  the  Middle  States  and 
thousands  of  national  institutions  doing  business  in  the 
agricultural  sections. 

The  Country  Banks. — The  country  banks,  by  the  terms 
of  the  National  Bank  Act,  are  required  to  keep  a  cash  re- 
serve at  ail  times  equal  to  fifteen  per  cent  of  their  deposits. 
Under  the  old  law  the  country  bank  must  keep  only  forty 
per  cent  of  this  required  reserve  in  its  o\\ti  vaults,  while  it 
is  allowed  to  deposit  sixty  per  cent  of  the  required  reserve 
on  call  in  such  national  banks  in  any  of  the  reserve  cities 
or  central  reserve  cities  as  may  be  approved  as  "reserve 
agents"  for  it  by  the  Comptroller  of  the  Currency.  Thus 
it  follows  that  if  a  country  bank  has  $1,000,000  of  deposits 
it  must  keep  a  reserve  equal  to  at  least  $150,000,  of  which 
$G0,000  must  be  in  its  own  vaults  and  $90,000  may,  if  the 
bank  so  desires,  be  kept  on  deposit  with  the  national  bank  or 
linnks,  which  have  been  approved  as  its  reserve  agents, 
located  in  either  a  reserve  city  or  a  central  reserve  city. 
It  should  be  noted  that  the  bank  is  not  required  to  keep  any 
portion  of  its  cash  reserve  on  deposit  with  reserve  city  or 
central  resen^e  city  banks ;  it  may  all  be  kept  in  its  vaults, 
if  the  bank  so  elects.     It  is  very  probable,  however,  that 


204       OPERATION  OF  THE  NEW  BANK  ACT 

there  is  not  a  single  national  bank  in  the  country  which 
follows  the  practice  of  keeping  its  entire  reserve  in  its  own 
vaults.    The  reasons  for  this  will  be  developed  a  little  later. 

The  Reserve  and  Central  Reserve  Cities. — The  second 
class  of  national  banks,  known  as  reserve  city  banks,  in- 
cludes all  national  banks  located  in  forty-seven  cities  of 
the  country,  which  from  time  to  time  have  been  designated 
as  reserve  cities.  Every  national  bank  in  them  is  required 
to  keep  a  reserve  at  all  times  equal  to  at  least  twenty-five  per 
cent  of  its  deposits.  It  must  be  borne  in  mind  that  the 
deposits  of  a  reserve  city  bank  include  not  only  what  the 
banker  refers  to  as  individual  deposits — the  deposits  of 
individuals,  firms,  partnerships  and  corporations — but  also 
deposits  which  have  been  made  with  the  reserve  city  bank 
by  country  banks,  for  which  it  is  the  reserve  agent. 

A  reserve  city  bank  is  permitted  by  the  National  Bank 
Act  to  keep  one-half  of  its  required  reserve  on  deposit,  sub- 
ject to  withdrawal  on  demand,  in  a  national  bank  or  banks 
in  a  central  reserve  city,  approved  by  the  Comptroller  of 
the  Currency,  as  its  reserve  agent.  Thus,  under  the  law  a 
reserve  city  bank  with  $1,000,000  of  deposits  must  keep  a 
reserve  of  at  least  $250,000,  of  which  $125,000  must  be  in 
its  own  vaults,  while  the  balance  of  $125,000,  or  so  much 
of  it  as  the  bank  desires,  may  be  on  deposit  with  a  central 
reserve  city  bank. 

Every  national  bank  within  the  central  reserve  cities 
must  keep  a  reserve  equal  in  amount  to  at  least  twenty-five 
per  cent  of  its  deposits,  including  not  only  individual  de- 
posits but  deposits  by  bankers  for  whom  it  acts  as  reserve 
agent  or  correspondent. 

The  Reasons  for  the  System. — This  rather  complicated 
system  of  reserves  was  authorized  by  Congress  because  it 
was  necessary  to  allow  the  banks  of  the  country  districts 
or  smaller  cities  to  keep  reserves  in  other  banks  in  the  larger 
centers  of  trade  in  order  to  facilitate  the  commercial  ex- 
changes of  the  country ;  and  also  because  it  was  necessary 
to  have  some  means  by  which  banks  of  the  larger  cities  could 
finance  payments  for  their  customers  in  the  great  centers 


THE  RESERVE  PROBLEM  ^205 

of  the  country,  especially  in  New  York,  Chicago  and  St. 
Louis.  For  these  reasons  it  was  felt  to  be  perfectly  proper 
to  permit  the  carrying  of  a  part  of  the  reserves  of  country 
banks  and  of  the  reserve  city  banks  in  the  vaults  of  other 
institutions.  Such  a  practice  has  brought  a  certain  degree 
of  mobilization  of  cash  reserves,  which  it  was  anticipated 
would  be  of  advantage  to  the  country. 

Its  Weaknesses. — Our  system  of  deposited  reserves 
has  failed  miserably  in  times  of  stress,  although  it  has 
worked  reasonably  well  in  ordinary  times.  It  is  contended 
that  it  has,  to  a  large  degree,  built  up  the  great  centers, 
and  more  especially  New  York  City,  at  the  expense  of 
country  districts.  It  has  been  responsible  for  the  seasonal 
withdrawal  of  money  which  was  at  one  time  a  most 
serious  embarrassment  to  business,  especially  in  New 
York,  Chicago  and  other  large  cities  in  the  fall  months, 
but  which  has  practically  disappeared  in  New  York 
City  since  the  panic  of  1907.  However,  the  fact  that  this 
system  persisted  for  half  a  century  without  any  suc- 
cessful attempt  being  made  to  alter  it  indicates  that,  while 
the  defects  may  have  been  serious,  they  were  not  sufficiently 
grave  to  bring  about  any  change.  It  was  not  until  the  sys- 
tem of  deposited  reserves  brought  about  the  panic  of  1907 
that  the  country  at  large  became  convinced  that  this  feature 
of  the  national  banking  system  was  vicious,  dangerous  and 
likely  to  produce  trouble  at  any  time.  "With  this  conviction 
began  the  movement  which  finally  ended  in  the  enactment 
of  the  Federal  Kosoi'vc  Act. 

Much  of  Our  Reserve  Fictitious. — As  a  matter  of  fact, 
the  actual  available  reserves  of  the  three  classes  of  national 
banks  in  the  country  are  much  less  than  is  indicated  by  the 
percentage  specified  in  the  Act  quoted  above.  According 
to  the  report  of  the  Comptroller  of  the  Currency  as  of 
October  21,  1913,  the  country  banks  held  in  round  numbers 
$294,000,000  of  cash  in  their  vaults  and  had  on  deposit  in 
the  reserve  city  and  central  reserve  city  banks  $534,000,000. 
The  reserve  city  banks  held  $251,000,000  of  cash  and  had  on 
deposit  with  the  central  reserve  city  banks  $258,000,000. 


206       OPERATION  OF  THE  NEW  BANK  ACT 

At  the  same  date  the  central  reserve  city  banks  held  in  cash 
$381,000,000.  The  central  reserve  city  banks  on  the  same 
date  owed  other  national  banks  $540,000,000  and  had  on 
deposit  from  State  banks,  trust  companies  and  savings 
banks  over  $424,000,000 — in  all  a  total  of  bankers'  deposits 
exceeding  $964,000,000,  as  compared  with  $993,000,000  of 
individual  deposits  held.  Now  it  is  obvious  that  these 
national  banks  of  the  central  reserve  cities  could  not  by  any 
possibility  return  to  the  reserve  city  and  country  banks,  for 
whom  they  acted  as  reserve  agents,  the  portion  of  the 
reserves  deposited  with  them.  They  owed  these  institutions 
almost  $1,000,000,000,  while  the  cash  which  they  possessed 
aggregated  only  $381,000,000.  Similarly  the  reserve  city 
banks  on  the  same  date  owed  national  banks.  State  banks, 
trust  companies  and  savings  banks  over  $918,000,000 
against  which  they  held  cash  to  the  amount  of  $251,000,000, 
and  could  theoretically,  although  never  actually,  receive  at 
any  time  upon  call  $258,000,000,  which  they  had  on  deposit 
with  national  banks  in  the  central  reserve  cities.  This 
condition  is  referred  to  frequently  as  the  pyramiding  of 
reserves,  which  means,  in  substance,  that  the  national  banks 
of  this  country,  omitting  from  consideration  the  State  banks 
where  the  same  condition  exists  in  an  even  more  aggravated 
form,  are  doing  business  largely  upon  a  paper  reserve, 
which  experience  has  shovm  is  utterly  useless  in  times  of 
panic.  The  seven  thousand  five  hundred  and  nine  national 
banljs  held  cash  and  paper  reserves  on  October  21,  1913,  as 
follows : 

Cash  in  vaults.  Due  from  banks. 

Country  banks  $294,000,000  $534,000,000 

Reserve  city  banks 251,000,000  258,000,000 

Central  reserve  city  banks 381,000,000  

$926,000,000  $792,000,000 

As  a  matter  of  fact  the  national  banks  of  the  country 
held  $926,000,000  in  cash  as  against  total  deposits  subject 
to  reserve  requirements  of  $7,172,000,000  or  about  12.8 
per  cent  of  the  liabilities  subject  to  the  requirements. 

Dangers  of  the  System. — So  conclusive  are  the  lessons 


THE  RESERVE  PROBLEM  207 

to  be  learned  from  the  experience  of  the  last  half  century 
with  the  system  of  redeposited  reserves,  that  there  is  a 
practical  unanimity  among  bankers  and  financial  experts 
that  the  reserves  of  our  banks,  with  the  exception  of  the 
money  actually  held  in  the  vaults,  are,  in  the  words  of 
William  Ingle,  Vice-President  of  the  Merchants  and 
Mechanics  National  Bank  of  Baltimore,  "A  great  deal  of 
a  delusion  and  a  snare."  In  every  panic,  the  country  banks 
and  the  reserve  city  banks  have  found  that  it  has  been  im- 
possible for  them  to  secure  the  return  of  the  portion  of  these 
reserves  which  has  been  redeposited  in  New  York,  Chicago, 
and  St.  Louis.  At  a  time  of  great  stress,  when  the  banks 
have  been  subjected  to  a  drain,  they  have  been  suddenly 
bereft  of  the  support  which,  in  theory,  should  have  been 
forthcoming  from  their  reserve  agents,  and  have  been 
forced  to  depend  upon  the  six  per  cent  or  twelve  and  a  half 
per  cent  reserve,  which  was  contained  in  their  own  vaults. 
What  is  even  worse,  the  outbreak  of  a  panic  in  New  York 
City,  where  every  panic  of  the  last  half  century  has  started, 
was  the  signal  for  the  suspension  of  cash  payments  by  every 
bank  in  the  country,  within  a  few  hours.  As  soon  as  the 
demands  for  cash  from  the  New  York  banks  were  met  with 
a  refusal,  or  as  soon  as  it  became  apparent  that  the 
New  York  banks  were  about  to  be  forced  through  the  neces- 
sity of  self-preservation  to  suspend  payment,  practically 
every  bank  the  country  over  followed  suit  for  its  own  self- 
protection.  Thus  a  local  panic,  in  many  cases  occurring 
M'hen  business  conditions  were  exceedingly  prosperous  and 
healthy,  has  completely  disorganized  the  exchanges  of  the 
country  and  brought  business  to  a  standstill. 

The  Changes  Provided. — The  greatest  advantage  of 
the  i-ogional  system  is  that  the  eountrj^  will  no  longer  be 
dependent  upon  the  tranquillity  of  the  financial  situation 
in  a  single  large  city  of  the  nation.  The  disturbance  of 
conditions  in  New  York  will  afTect  chiefly  the  section  com- 
prised within  the  t(>rritorv  of  the  reserve  bank  of  New 
York;  and  if  the  other  reserve  banks  of  the  country  have 
followed  a  conservative  policy,  it  should  exert  little  more 


208       OPERATION  OF  THE  NEW  BANK  ACT 

influeuce  upon  the  territory  of  the  other  reserve  banks  than 
such  disturbances  in  this  country  now  affect  England, 
Germany  or  France.  If  a  rather  clumsy  simile  may  be  per- 
mitted, we  might  compare  our  present  system  to  a  huge 
warehouse  in  which  fire  can  sweep  from  one  end  to  the 
other  without  check,  but  which  is  now  to  be  divided  into 
from  eight  to  twelve  sections  by  fire  walls.  A  conflagration 
starting  in  any  section  can  be  confined  largely  to  that  sec- 
tion, and  through  the  other  sections  of  the  warehouse  aid 
may  come  to  fight  the  fire  •which  has  thus  been  localized. 

Past  Difficulties  Due  to  a  Bad  System. — In  justifica- 
tion of  the  New  York  banks  it  should  be  made  clear  that 
their  failure  to  return  the  cash  of  the  country  banks  is  not 
due  to  flagrant  disregard  of  their  obligations,  but  to  the  de- 
fects inherent  in  the  situation,  the  evils  of  which  they  can 
not  overcome.  As  Mr.  Ingle  stated,  the  reserves  are  "ficti- 
tious," in  that  instead  of  being  a  cash  reserve,  as  would  be 
indicated  by  the  name,  they  are  paper  reserves.  That  is 
to  say,  they  have  been  built  up  through  the  deposit  of  checks, 
drafts,  and  other  negotiable  paper,  and  as  a  matter  of  fact 
the  New  York  banks  have  never  had,  and  could  not  secure, 
without  a  complete  disorganization  of  commerce,  the  cash 
equivalent  of  the  redeposited  reserves  of  the  country  banks 
with  them. 

Illustrations. — The  exact  situation  is  well  illustrated 
by  a  portion  of  the  testimony  of  Mr.  George  ^I.  Reynolds, 
President  of  the  Continental  and  Commercial  National  Bank 
of  Chicago,  the  second  largest  national  bank  in  the  United 
States,  in  which  he  describes  one  of  his  experiences  in  the 
panic  of  1907.  Mr.  Reynolds  says :  "At  the  time,  one  of  my 
junior  officers  came  to  me  and  said,  'One  of  our  customers 
is  here  and  he  is  verj^  boisterous  and  he  is  very  excited,  and 
he  says  that  he  wants  to  get  out  what  he  put  into  our 
bank.'  I  said,  'Well,  there  is  no  trouble  about  that.'  He 
said,  'Well,  this  man  is  very  much  exercised  and  I  think 
you  had  better  see  him.'  So  they  showed  the  gentleman  in. 
I  said  to  him,  'What  can  I  do  for  you?'  He  said,  'What  is 
the  matter  with  this  bank?    What  is  the  reason  that  I  can 


THE  RESERVE^PROBLEM  209 

not  get  out  of  this  bank  what  I  put  into  it?'  I  said,  'Why, 
there  is  no  trouble  about  that.  I  am  sure  your  idea  must 
be  entirely  erroneous.'  'Well,'  he  said,  'this  is  the  fii'st 
intimation  I  have  had  of  any  encouragement  at  all  along 
that  line.'  I  said,  'Sit  down  and  let  us  see  what  the  trouble 
is.'  I  investigated  the  matter  and  found  that  his  bank  had 
$67,000  on  deposit  with  us,  and  then  I  said  to  him,  'Ver\' 
well,  we  will  give  you  back  what  you  gave  us. ' 

"I  found  that  in  the  make-up  of  that  $67,000  there  was 
$13,000  of  sundry  items,  payable  all  over  the  country,  in 
his  cash  letter  just  received.  Then  I  said,  'By  way  of 
doing  what  I  said  we  will  do,  here  is  your  letter  and  your 
$13,000  of  sundry  items.  Now  we  owe  you  $5-4,000.  Now 
we  will  prepare  a  bundle  of  checks  indiscriminately,  for 
that  is  the  sort  of  checks  you  gave  us,  aggregating  $54,000, 
and  we  will  give  them  back  to  you,  and  we  then  will  have 
given  you  what  you  deposited  with  us." 

"  He  said,  'I  do  not  want  that;  I  want  the  money.'  I 
said,  'I  beg  your  pardon;  your  statement  was  that  you 
Avanted  what  you  put  into  this  bank.'  'Well,'  he  said, 
'what  I  want  is  the  money.' 

"I  said,  'What  you  want  of  us  is  to  let  you  and  j'our  com- 
munity accumulate  these  checks,  no  matter  what  they  may 
be,  and  you  want  to  send  them  to  us,  and,  in  time  of  emer- 
gency, you  want  me  to  be  a  magician  and  turn  these  checks 
into  bank  notes  because  every  bank  upon  which  we  could 
hope  to  realize  upon  them  in  cash  is  absolutely  closed 
through  public  fear  and  distrust  of  the  bank.'  " 

Later  on  in  his  testimony  ]\rr.  Reynolds  explains  how 
even  to  the  country  bank  itself  its  deposit  in  the  reserve 
bank  is,  to  a  large  degree,  a  fictitious  reserve.  He  takes  as 
an  illustration  the  case  of  a  merchant  who  goes  to  his  bank 
and  says,  "  'I  want  a  $10,000  Chicago  draft.'  The  banker 
probably  has  $10,000  or  $12,000  at  Chicago,  and  it  might 
be  $2,000  or  $3,000  more  than  tlie  legal  requirement  would 
make  it  necessary  for  him  to  carr}%  but  he  would  have  to 
carry  this  additional  $2,000  or  $3,000  in  order  to  give  you 

14 


210       OPERATION  OF  THE  NEW  BANK  ACT 

that  cheek.  He  goes  to  a  grain  merchant  that  night  and 
says,  'I  have  got  to  have  some  Chicago  exchange  and  you 
are  owing  me  some  money  and  I  am  carrying  that  grain.  I 
will  have  to  realize  against  it.  You  must  load  up  two  or 
three  cars  of  grain  and  send  it  into  Chicago,  and  draw  your 
draft  against  the  commission  merchant,  attach  the  bill  of 
lading,  and  make  some  exchange  for  me. '  The  moment  he 
gives  that  draft,  attached  to  that  bill  of  lading,  it  is  entered 
on  his  books,  and  in  the  meantime  the  cars  of  grain  are 
started  on  their  journey  to  Chicago,  which  may  be  one  or 
two  days  distant  from  that  point ;  and  it  is  a  reserve  under 
the  law  the  moment  he  enters  it  on  his  books." 

The  Effect  of  "  Interchange  of  Credit." — In  other  words, 
if  it  were  possible  to  make  an  instantaneous  comparison 
of  the  books  of  the  country  bank  and  of  its  Chicago  reserve 
agent,  we  would  find  that  the  country  bank  had  credited 
to  itself  on  its  own  books  items  which  would  raise  its  reserve 
several  thousand  dollars  above  the  amount  that  w^ould  ap- 
pear on  the  books  of  the  Chicago  bank.  This  condition  is 
a  continuous  one,  for  the  daily  remittances  which  contain 
a  miscellaneous  collection  of  checks,  drafts,  etc.,  are  credited 
on  the  books  of  the  country  bank  to  its  own  reserve  account 
when  they  are  put  into  the  mail,  whereas  it  will  probably 
be  several  days  before  the  reserve  agent  will  grant  this  credit 
to  the  country  bank  upon  its  own  books.  The  enormous 
volume  of  these  items  is  shown  by  the  following  remark 
by  Mr.  Reynolds,  **You  will  see  it  means  a  great  deal  when 
I  tell  you  that  the  institution  with  which  I  am  connected 
last  year  accepted  and  turned  into  cash  or  its  equivalent, 
for  immediate  use  over  our  counter,  $2,500,000,000  of  what 
we  call  'outside  items,'  represented  by  19,000,000  different 
checks.  You  will,  from  that  statement,  get  the  idea  a  little 
better,  perhaps,  of  what  I  mean  by  an  interchange  of 
credit." 

In  much  the  same  way,  the  counter-current  sent  by  the 
reserve  centers  to  the  country  banks  for  collection  tends  to 
give  a  fictitious  appearance,  even  from  the  standpoint  of 
the  book  account  itself,  to  the  reser^^es  of  the  country  banks. 


THE  RESERVE  PROBLEM  211 

Mr.  Ingle,  in  connection  with  his  statement  that  the  rede- 
posited  reserves  are  largely  "a  delusion  and  a  snare,"  en- 
gaged in  the  following  interesting  colloquy  with  Senator 
Hitchcock : 

' '  Senator  Hitchcock.  Whenever  an  individual  citizen  of 
Baltimore  draws  a  check  on  your  bank  which  goes  to  New 
York  and  gets  in  the  hands  of  your  New  York  correspond- 
ent, does  that  New  York  correspondent  charge  that  check 
to  your  account? 

Mr.  Ingle.  If  in  connection  with  it  or  any  one  of  the 
four  New  York  correspondents  we  have,  it  does  it  that  very 
minute. 

Senator  Hitchcock.  What  do  you  mean  by  any  one  of 
your  New  York  correspondents  ? 

Mr.  Ingle.  I  have  different  arrangements,  sir,  with  dif- 
ferent banks. 

Senator  Hitchcock.  You  mean  to  say  you  have  four 
New  York  correspondents 

Mr.  Ingle  (interposing).  And  they  will  charge  that 
check  on  Baltimore,  or  any  other  check  they  choose  to  send 
up  drawTi  on  Baltimore,  direct  to  our  balance  in  their-hands. 

Senator  Hitchcock.  If  John  Smith,  in  Baltimore,  draws 
a  check  on  your  bank,  your  correspondent  charges  that  up 
to  your  account? 

Mr.  Ingle.    Up  to  my  account. 

Senator  Hitchcock.     Without  submitting  it  to  you. 

Mr.  Ingle.  I  get  it  the  next  morning,  and  I  am  given  a 
debit  for  it. 

Senator  Hitchcock.  Let  me  ask,  when  is  it  charged  to 
you? 

Mr.  Ingle.  The  very  moment  he  gets  it ;  the  very  moment 
he  gets  it  he  debits  it. 

Senator  Hitchcock.  I  say  is  that  the  practice  of  country 
bank  correspondents? 

Mr.  Ingle.  I  say  I  can  only  tell  you  from  our  experi- 
ence. I  say  it  is  a  growing  and  vicious  practice,  in  my  judg- 
ment. 

Senator  Hitchcock.    Which  is  the  \ncious  practice? 


212       OPERATION  OF  THE  NEW  BANK  ACT 

Mr.  Ingle.  This  thing  of  permitting  the  maintenance  of 
those  double  accounts. 

Senator  Hitchcock.  What  do  you  mean  by  maintaining 
double  accounts? 

Mr.  Ingle.  I  am  speaking  of  that  situation  which  you 
pictured,  where  we  have  a  balance  in  New  York,  and  where 
New  York  will  send  us  business  from  day  to  day  for  collec- 
tion and  remittance  either  upon  receipt,  or  after  three 
days,  or  next  week,  if  you  choose.  Now,  what  does  this 
practice  result  in  ?  We  are  assumed  to  keep  twenty-five  per 
cent  reserve.  Can't  you  see,  if  any  bank  has  a  balance  to 
its  credit  in  New  York  of  $500,000  it  will  also  have  $500,000 
cash  in  its  vaults.  The  two  sums  together  may  represent 
the  twenty-five  per  cent  on  that  bank's  deposits.  Now,  if 
that  New  York  bank  sends  its  out-of-town  bank  business 
from  day  to  day,  for  remittance  twice  a  week,  let  us  assume 
the  paying  bank  may  accumulate  from  the  New  York  bank 
$250,000  worth  of  business  to  be  remitted  for  twice  a  week. 
Now,  in  practice,  what  do  many  banks  do?  They  continue 
to  count  as  reserve  the  full  debit  balance  of  $500,000.  And, 
as  we  all  know,  a  reserve  is  only  maintained  at  all  with  a 
view  of  protecting  depositors  of  a  bank  in  case  of  failure  or 
liquidation — if  we  never  failed  we  would  not  want  any 
reserve.  You  see  that  means  our  reserve  the  moment  the 
bank  fails ;  it  is  not  our  total  debit  balance  in  New  York ;  it 
is  that  total  debit  balance  less  the  balance  we  may  have  on 
our  books  from  New  York  for  remittance  at  any  particular 
time  in  the  future.  So  that  instead  of  having  $500,000  re- 
serve, we,  as  a  matter  of  fact,  only  have  $250,000  reserve. 

Senator  Hitchcock.  You  mean  New  York  has  sent  vou 
$250,000 

Mr.  Ingle  (interposing).  For  collection  and  remittance 
once  a  week,  if  you  choose — an  accumulating  balance.  The 
practice  is,  where  it  is  done  for  accumulating  balances,  it 
sends  a  very  small  balance  the  first  three  or  four  days  and 
a  very  large  one  on  the  fifth  or  sixth  day  to  save  the  New 
York  bank. 

Senator  Hitchcock.    To  save  the  New  York  bank? 


THE  RESERVE  PROBLEM  213 

Mr.  Ingle.  The  New  York  bank  gets  its  return  quickly. 
For  instance,  one  bank  in  Baltimore  will  arrange  to  remit 
for  a  certain  New  York  bank  on  Wednesdays  and  Saturdays 
each  week.  That  New  York  bank  will  arrange  with  another 
Baltimore  bank  to  remit  it  twice  weekly,  on  Tuesdays  and 
Fridays,  and  so  on,  possibl}'  with  a  third  bank  on  Wednes- 
days— on  the  other  two  days.  Now,  in  sending  their  de- 
posits they  so  arrange  it  that  their  money  will  be  away 
from  them  the  shortest  possible  time,  which  is  a  very  excel- 
lent idea  from  their  point  of  view. 

Senator  Hitchcock.    You  mean  New  York  does  that? 

Mr.  Ingle.  New  York  does ;  yes.  The  idea  that  I  insist 
upon  in  opposition  to  this  double  account  business  is  this: 
That  a  bank  which  keeps  its  reserve  honestly,  which  tries 
to  keep  a  reserve  of  twenty-five  per  cent — and  if  it  does  not 
it  can  not  help  itself,  it  is  gone,  in  tight  times  or  for  some 
other  reason — such  a  bank,  in  trying  to  keep  its  reserve, 
only  figures  as  its  reserve  its  actual  balance  in  New  York 
plus  its  cash  on  hand.  Now,  if  those  full  debit  balances  are 
permitted  to  be  counted,  can't  you  see  that  the  bank  which 
does  that  and  makes  no  deduction  for  offsetting  balances 
has  a  very  superior  advantage  over  a  bank  which  insists 
upon  a  single  account,  in  which  is  always  reflected  the  actual 
amount  of  money  the  owning  bank  can  draw  for  in  case  it 
has  to  have  it. 

Senator  Hitchcock.  You  say  you  have  $7,000,000  of 
country-bank  deposits  ? 

Mr.  Ingle.    Yes. 

Senator  Hitchcock.  Suppose  you  receive  a  batch  of 
checks  against  one  of  those  country  banks  in  a  country  town 
in  your  State ;  do  you  charge  those  checks  to  the  account  of 
that  country  ])ank  when  you  receive  them  ? 

Mr.  Ingle.  I  think  so;  in  our  ease  in  seventy-five  per 
cent  of  our  accounts. 

Senator  Hitchcock.  Does  that  depend  altogether  on  the 
arrangement  between  the  brinks? 

Mr.  Ingle.  Altogetlier  on  the  nrrancrement  between  the 
banks,  and  sometimes  they  nre  clmncrod. 


214       OPERATION  OF  THE  NEW  BANK  ACT 

Senator  Hitchcock.  Suppose  you  send  that  country  bank 
collection  items;  when  do  you  charge  them  with  those  items? 

Mr.  Ingle.  Only  upon  receipt  from  that  bank  of*  advice 
of  their  payment.  We  charge  them,  as  a  matter  of  fact,  one 
or  two  days  after  they  have  the  money.     *     *     * 

Senator  Hitchcock.  You  say  with  seventy-five  per  cent 
of  your  country  bank  customers  you  charge  checks  to  them 
just  the  minute  you  receive  them  ? 

Mr.  Ingle.  I  think  I  am  approximately  correct  there,  sir. 
I  say  it  is  substantially  so  in  the  ease  of  800  correspondents ; 
I  do  not  follow  it  personally,  but  I  feel  I  know  it." 

From  the  examination  of  other  bankers,  it  appears  that 
the  practice  outlined  by  Mr.  Ingle  is  not  universal  and  that, 
in  fact,  a  very  large  group  of  country  bankers  wiU.  not 
allow  their  New  York  reserve  agents  to  charge  checks 
against  them  when  received,  insisting  that  the  checks  be 
forwarded  to  them  for  collection  and  that  they  remit  to  the 
reserve  agent  after  the  checks  have  been  examined  and 
charged  to  the  account  of  the  customer  drawing  them.  A 
remittance  in  pajonent  of  the  collection  is  made,  as  a  rule, 
by  a  draft  drawn  by  the  bank  upon  the  correspondent  which 
forwarded  the  checks;  and  this  draft,  when  received,  is 
charged  against  the  account  of  the  remitting  bank  upon 
the  books  of  its  reserve  agent. 

Results  of  Current  Practices. — This  situation,  however, 
where  it  exists,  still  further  emphasizes  the  fictitious  char- 
acter of  the  reserves,  for,  as  a  matter  of  fact,  the  reserve 
agent  holds  a  large  amount  of  items,  consisting  of  checks 
and  drafts  deposited  with  it  by  its  customers  and  for  which 
it  has  given  credit  upon  its  books,  entitling  the  customer  to 
check  against  it  at  once.  This  amount  creates  a  large  pro- 
portion of  the  reserve  which  the  country  bank  is  carrying 
with  the  reserve  agents,  so  that  the  net  indebtedness  of  the 
reserve  agent  where  this  plan  exists  is  really  very  little. 

Country  bankers  are  very  free  in  declaring  that  their 
reserve  accounts  with  reserve  city  and  central  reserve 
city  banks  are,  to  a  large  degree,  nothing  but  checking  ac- 


THE  RESERVE  PROBLEM  215 

counts  which  they  would  have  to  maintain  in  any  event  for 
the  purpose  of  selling  exchange. 

Mr.  A.  F.  Dawson,  President  of  the  First  National  Bank 
of  Davenport,  Iowa,  in  testifying  before  the  Senate  Com- 
mittee, stated  that,  "The  First  National  Bank  of  Daven- 
port, Iowa,  is  required  to  keep  its  reserve  in  either  Chicago, 
St.  Louis,  New  York,  or  some  other  reserve  city.  Along  with 
the  question  of  reserves,  there  is  the  question  of  daily  ex- 
change. I  asked  the  boys  in  the  bank  to  figure  up  how 
active  our  New  York  and  Chicago  accounts  were.  Most  of 
the  financial  relations  of  our  portion  of  Iowa  are  in  the 
direction  of  Chicago,  rather  than  in  the  direction  of 
St.  Louis,  although  we  have  considerable  business  in 
that  direction  also.  I  found  that  our  Chicago  balance 
turned  over  every  two  days  in  the  matter  of  exchange. 
In  other  words,  we  were  writing  a  sufficient  number  of 
drafts  on  Chicago  banks  every  two  days  to  wipe  out  our 
balance  there,  and  that  balance  was  larger  than  the  reserve 
which  we  were  required  by  law  to  cann^ 

Senator  Hitchcock.  What  methods  do  you  accept  to 
restore  that  balance?    What  proportion  is  in  currency? 

Mr.  Dawson.  There  is  no  currency;  they  are  items  of 
credit. 

Senator  Hitchcock.    No  currency? 

Mr.  Dawson.  No  currency  at  all;  we  never  ship  cur- 
rency to  Chicago. 

Our  New  York  acr-ount  shows  the  activity  of  the  rela- 
tions between  the  mid-Wost  and  the  financial  metropolis. 
Our  New  York  account  turns  over  once  in  every  three  days. 
We  sell  enough  New  York  exchange  every  three  days  to 
wipe  out  the  balances  we  carry  in  New  York. 

Senator  Brerl.  You  would  have  to  have  that  much 
money  there,  whether  you  had  a  reserv'e  or  not? 

Mr.  Dawson.  Yory  nearly  so,  unless  there  would  be  some 
change  in  the  existing  practices  in  the  world  of  banking." 

The  Difference  between  Gross  Deposits  and  Net 
Deposits. — Tbis  livings  iis  tn  n  rntlicr  ti'r'bni(\al  bnt  vei\v 
important  distinction  wbiob  has  growTi  up  concerning  the 


216  .    OPERATION  OF  THE  NEW  BANK  ACT 

differences  between  what  bankers  know  as  * '  gross  deposits ' ' 
and  ''net  deposits."  This  was  very  ably  explained  by  i\Ir. 
Frank  A.  Vanderlip,  who  testified  that  the  ' '  National  Bank 
Act  merely  states  that  a  reserve  shall  be  kept  upon  the  de- 
posits. It  does  not  state  whether  these  are  net  or  gross 
deposits.  Gross  deposits  are  the  total  deposits  to  the  credit 
of  the  depositors  in  the  bank.  Net  deposits  are  the  deposits 
after  certain  deductions,  among  which  are  all  items  that 
are  in  the  process  of  collection.  For  example,  if  a  bank  in 
New  York  has  $10,000,000  of  deposits,  and  a  bank  in  Pitts- 
burgh deposits  a  check  drawn  on  a  Chicago  bank  for 
$1,000,000,  the  gross  deposits  of  the  New  York  bank  would 
be  $11,000,000,  but  in  figuring  the  reserves  we  would  deduct 
the  $1,000,000  check  until  it  had  been  collected,  and  we 
would  figure  our  reserve  on  $10,000,000,  which  is  the  amount 
of  the  net  deposits." 

At  the  same  time,  however,  the  Pittsburgh  bank  has  in- 
creased its  reserve,  through  the  deposit  of  the  $1,000,000 
check,  by  that  amount ;  although  the  New  York  bank  is  not 
keeping  any  reserve  against  its  bankers'  deposit  represented 
by  this  check.  The  Federal  Reserve  Act,  as  passed  by  the 
House,  did  not  state  whether  the  reserves  which  the  mem- 
ber banks  should  keep  should  be  based  upon  the  gross  or 
net  deposits.  If  the  reserve  were  to  be  figured  on  the  gross 
deposits  and  these  Federal  reserve  banks  were  to  under- 
take all  the  collections  of  the  country,  as  it  is  hoped  will 
be  the  case,  there  would  be  a  mass  of  deposits  with  them 
which  would,  in  fact,  consist  only  of  items  in  process  of 
collection  but  against  which  they  would  have  to  keep  re- 
serves. This  mass  of  items  in  the  process  of  collection  would 
be  so  great  in  all  probability  that  it  would  use  up  a  large 
part  of  the  reserve  bank's  available  funds  through  the  extra 
reserve  which  it  must  keep.  Mr.  Vanderlip,  among  other 
bankers,  advocated  that  the  reserve  banks  should  be  per- 
mitted to  deduct  items  in  process  of  collection,  while  at  the 
same  time  the  depositing  bank  would  be  forbidden  to  count 
uncollected  items  in  its  reser\^e,  being  required  to  credit 
such  items  to  its  reserve  account  only  when  collection  had 


THE  RESERVE  PROBLEM  217 

been  made.  This  suggestion  was  so  sound  that  the  follow- 
ing provision  was  incorporated  in  the  bill : 

"In  estimating  the  reserves  required  by  this  Act,  the 
net  balance  of  amounts  due  to  and  from  other  banks  shall 
be  taken  as  the  basis  for  ascertaining  the  deposits  against 
which  reserves  shall  be  determined.  Balances  in  reserve 
banks  due  to  member  banks  shall,  to  the  extent  herein  pro- 
vided, be  counted  as  reserves." 

Paying  Interest  on  Deposits. — Strong  as  is  the  case  in 
support  of  the  value  of  the  reserve  balances  of  the  national 
banks  with  correspondents,  yet  the  fact  nevertheless  re- 
mains that  these,  to  a  large  degree,  have  been  unnaturally 
forced  through  the  payment  of  interest  by  the  reserve  agents 
to  their  correspondents  upon  these  balances.  In  fact,  a 
large  proportion  of  these  bankers'  balances  have  been  built 
up  through  the  practice  of  paying  interest  averaging  about 
two  per  cent  per  annum  upon  such  balances.  While  this 
rate  of  return  is  very  small,  yet  it  is  potent  for  the  reason 
that  the  country  bank  must  keep  this  reserve  under  the 
law.  If  in  its  own  vaults  it  is  absolutely  idle  and  brings 
in  no  return,  while  if  deposited  with  the  reserve  agent  it 
will  bring  in  two  per  cent,  besides  giving  the  bank  great 
advantages  in  handling  its  exchange  business. 

The  practice  of  paying  interest  upon  deposits  has  be- 
come so  universal  among  the  reserve  agents  that  little  com- 
ment is  aroused  at  the  present  time.  When  it  was  in  process 
of  development  it  met  with  great  opposition.  It  is  impor- 
tant in  this  connection  to  set  down  the  following  excerpt 
from  the  report  of  the  committee  appointed  by  the  New  York 
Clearing  House  Association  to  considei-  and  report  what  re- 
forms were  required  in  the  operations  of  banks  with  each 
other  and  with  the  public,  to  increase  the  security  of  their 
business,  following  the  panic  of  1873.  The  Committee 
pointed  out  that  deposits  derived  from  "strictly  commercial 
operations"  can  not  fluctuate  so  widely  from  time  to  time  as 
to  produce  disturbance  in  the  community,  but  "that  on  the 
contrary  deposits  which  are  purchased  by  the  payment  of 
interest  or  othoi-wise  and  which  nnist,  therefore,  of  neces- 


218      OPERATION  OF  THE  NEW  BANK  ACT 

sity  be  largely  loaned  'on  demand,'  are  the  cause  of  con- 
tinual agitation  and  solicitude  to  those  who  hold  them  in 
charge.  They  are  certain  to  be  withdrawn  at  the  season 
of  the  year  and  at  the  moment  most  inconvenient  to  the 
banks  and  to  their  dealers.  *  *  *  These  deposits  were 
to  a  large  extent  loaned  upon  stocks  and  bonds  in  Wall 
Street,  paj^able  'on  call,'  with  the  confident  belief  that  they 
were  there  earning  more  than  the  interest  paid  for  securing 
them,  and  were  available  as  promised.  But,  from  the  very 
nature  of  the  case,  the  rapid  withdrawal  of  deposits  from 
the  banks  made  the  'call'  from  every  direction  simultaneous 
and  closed  every  resource  from  which  the  'street'  derived 
its  power  to  respond.  Borrowers  upon  stocks  were  de- 
prived both  of  their  facilities  of  borrowing  and  of  all  power 
to  sell  their  securities.  The  necessary  result  occurred. 
Banks  which  found  themselves  in  this  dilemma  had  no 
alternative  but  to  ask  the  assistance  of  their  associates, 
and  the  conflagration  was  so  rapid  and  violent  that  every 
consideration  of  fraternal  sympathy,  self-preservation  and 
public  safety  compelled  a  general  and  earnest  cooperation; 
and  the  majority  who  had  for  long  years  conducted  their 
business  upon  sound  principles  and  who  had  patiently  sub- 
mitted to  the  loss  of  valuable  accounts,  drawn  from  them 
by  their  associates,  by  practices  against  which  they  had 
continually  protested,  instantly  responded  to  the  call  by 
placing  their  resources  at  the  command  of  those  who  had 
done  so  much  toward  producing  the  calamity;  making  com- 
mon cause,  the  weak  with  the  strong,  to  avert  a  universal 
catastrophe." 

Evil  Effects  of  the  Practice. — Bankers,  who  by  experi- 
ence are  associated  with  this  problem,  almost  without  ex- 
ception recognize  the  danger  pointed  out  by  the  Clearing 
House  Committee.  The  following  colloquy  between  Mr. 
Reynolds,  the  president  of  the  largest  bank  in  Chicago, 
and  Senator  Nelson  is  in  point : 

^'Senator  Nelson.  If  you  abolish  the  payment  of  interest 
on  bankers'  deposits  I  would  be  quite  willing,  speaking  for 


THE  RESERVE  PROBLEM  219 

myself,  to  leave  this  question  of  reserves  to  the  bauks,  to 
their  own  judgment. 

Mr.  Reynolds.  You  have  taken  the  words  out  of  my 
mouth." 

Again  further  on  the  same  banker,  whose  institution  has 
very  large  bankers '  deposits,  w^as  asked  the  question  whether 
if  the  law  prohibited  banks  of  reserve  cities  and  of  central 
reserve  cities  from  accepting  deposits  of  any  reserve  bank 
it  would  result  in  keeping  the  money  at  home.  He  replied : 
"Well,  I  think  it  would  to  some  extent,  but  that  money 
would  be  invested  at  home.  Then  the  question  of  whether 
it  would  be  invested  in  liquid  assets  and  whether  it  could 
be  readily  gotten  out  when  needed  is  a  question  that  would 
have  to  be  considered.  Of  course  the  exchange  require- 
ments would  make  it  necessary  to  carry  balances  in  large 
centers."  He  was  of  the  opinion  that  the  amount  of  re- 
serves to  be  kept  should  be  left  to  the  judgment  of  the 
member  banks. 

The  Federal  Reserve  Act  provides  that  after  we  have 
gone  through  several  preliminary  stages,  an  entirely  new 
-system  of  reserves  shall  be  created.  It  strikes  down  the 
present  practice  of  the  carrying  of  reserves  by  one  class 
of  national  banks  with  another,  and  substitutes  in  its  place 
a  system  by  which,  instead  of  the  concentration  of  a  large 
part  of  the  reserves  in  one  or  two  points,  as  New  York  or 
Chicago,  the  funds  of  the  member  banks  are  to  be  kept  in 
the  region  in  which  they  are  situated.  In  brief,  the  reserves 
are  to  be  held  either  in  the  vaults  of  the  member  bank 
itself  or  on  deposit  with  the  Federal  reserve  bank  of  which 
it  is  a  member.  Instead  of  all  the  banks  of  the  country  being 
knitted  together,  at  least  theoretically,  into  one  system,  the 
banks  in  each  region  are  to  centralize  their  reserves  with 
their  regional  bank.  At  the  same  time  important  changes 
were  made  in  the  proportion  which  the  resen'e  shall  bear 
to  the  deposits  of  a  bank. 


CHAPTER  XXI 

The  Redepositing  of  Reserves  under  the  New  Act 

What  Factors  Determine  a  Bank's  Reserve? — What 
elements  determine  the  proper  cash  reserve  for  a  bank? 
There  is  no  golden  rule  or  fixed  percentage;  and  strictly 
speaking,  the  reserves  which  two  banks  located  within  a  few 
feet  of  each  other  should  properly  carry  may  differ  widelj'. 
The  test  is  not  the  size  of  the  bank  or  necessarily  the  region 
in  which  it  is  situated.  It  is  the  character  of  deposits  which 
it  possesses,  that  is  to  say,  the  character  of  people  who  are 
depositors  and  the  general  character  of  the  business  in 
which  they  are  engaged.  Going  even  further,  the  question 
involves  the  function  which  the  deposits  play  in  the  business 
activities  of  the  depositors.  Thus,  for  example,  the  same 
man  may  have  two  accounts,  one  a  checking  account  from 
which  he  pays  his  ordinarj^  expenses,  and  the  other  a  savings 
account,  which  he  touches  only  in  an  emergency,  such  as 
sickness. 

It  is  really  impossible  to  specify  by  law,  with  scientific 
accuracy,  the  reserves  which  each  bank  should  keep.  The 
question  must,  to  a  large  degree,  be  solved  by  each  institu- 
tion for  itself,  and  a  few  moments  of  investigation  by  any 
one  will  disclose  differences  in  the  reserves  which  are  kept  by 
the  various  banks  in  his  own  neighborhood.  Generally  speak- 
ing, the  main  factors  to  be  considered  are  first,  the  character 
of  the  people  making  up  the  depositors;  second,  the  char- 
acter of  these  deposits — that  is,  whether  they  are  commercial 
savings  deposits  or  trust  deposits,  etc. ;  third,  the  converti- 
bility of  the  assets  in  which  the  funds  of  depositors  have 
been  invested ;  and  finally,  the  existence  of  a  market  in  which 
these  assets  may  upon  short  notice  be  converted  into  cash. 

Better  Form  of  Bank  Statement. — The  stereotyped 
form  of  bank  statement  in  this  country  is  in  many  respects 
unfortunate,  for  it  does  not  convey  any  information  as  to 
220 


REDEPOSITING  OF  RESERVES  221 

the  real  degree  of  convertibility  of  the  assets  of  the  report- 
ing bank.  It  would  be  much  better  were  our  banks  required 
to  list  separately  the  commercial  paper  maturing  within 
fifteen  days,  within  sixteen  to  thirty  days,  within  thirty-one 
to  sixty  days,  within  sixty-one  to  ninety  days,  and  after 
ninety  days,  as  is  done  by  some  European  institutions  and 
by  a  few  of  the  American  banks.  Such  a  bank  statement 
would  be  somewhat  in  the  form  of  the  following  statement, 
published  regularly  by  one  of  the  oldest  banks  in  Philadel- 
phia: 

PENN  NATIONAL  BANK 

Comptroller's  Call,  Jan.  13th,  1914 

Assets 
I ni mediately   Arailable: 

Cash   and   Reserve    $1,675,079.78 

Cliecks  for  Clearings   165,209.71 

Due  from   Correspondents    585,866.63 

Demand   Loans    1,118.484.18 

$3,544,640.30 
Available  icithi7i  30  days: 

Loans  due  in  30  days 1,401,153.50 

United  States  Bonds   200,000.00 

Otiier  Bonds  and  Investments     615,364.00 

$5,761,157.80 
Other  Loans  and  Discounts: 

Due  witliin  4  months 2.36."?.6S2.S8 

Due  after  4  months    399.308.29 

Banking  Property  257,130.32 

$8,781,279.29 

LlAR'LITlES 

Deposits $6..523.1 09.83 

Circulation     186.600.00 

Capital    Stock    .500.000.00 

Surplus  and  Profits   1,571.569.46 

.$8,781,279.29 

Liquid  Assets  and  the  Reserve. —  The  greater  the  pro- 
portion of  short-term  paper  which  the  bank  carries,  the 
smaller  is  the  amount  of  reserve  which  it  must  keep.  A 
bank  with  a  large  proportion  of  its  assets  maturing  and  be- 
ing redeemed  in  cash  eveiy  few  days  is  much  stronger  than 


222       OPERATION  OF  THE  NEW  BANK  ACT 

another  institution  carrying  a  larger  cash  reserve,  but  hold- 
ing assets  of  long  maturity. 

By  the  provisions  of  the  Federal  Reserve  Act,  the  re- 
serves of  national  banks  will  be  materially  reduced.  This 
reduction  is  prompted  by  the  changes  which  the  Act  will 
work  in  the  position  of  the  member  banks  by  increasing 
their  safety  and  security,  and  hence  causing  them  to  rely 
less  upon  themselves  than  heretofore.  In  the  beginning,  the 
creation  of  a  rediscount  market  will  be  of  great  assistance 
to  the  banks,  enabling  them  in  times  of  stress  to  convert 
their  commercial  paper  into  cash.  By  rediscounting  the 
bank  will  be  able  to  increase  its  cash  reserve  through  the 
larger  balances  which  it  will  create  with  the  Federal  reserve 
bank.  These  balances  can  be  turned  into  money  by  the 
member  bank  drawing  upon  the  regional  bank,  having  it 
ship  either  gold,  legal  tender,  its  own  or  Federal  reserve 
notes.  Instead  of  each  bank  relying  upon  the  sufficiency  of 
its  own  reserve,  together  with  the  part  which  it  can  theoreti- 
cally call  from  its  reserve  agents,  it  will  be  necessary  to  keep 
only  such  an  amount  of  money  as  will  meet  its  needs  until 
the  maehinerj^  of  rediscounting  can  be  put  into  operation. 

Proportion  of  Reserves  Actually  Available. — More- 
over, as  we  have  seen,  a  large  part  of  the  present  reserve 
is  of  little  or  no  value,  and  in  so  far  as  serviceability  in  times 
of  stress  is  concerned,  should  be  eliminated  from  anj'-  calcu- 
lations of  the  money  with  which  the  bank  could  hope  to  meet 
unusual  claims  of  depositors.  The  law,  therefore,  in  reduc- 
ing the  reserves  is  not  really  reducing  the  margin  of  safety. 
If  the  reserve  banks  are  conservatively  managed, — if  they 
follow  the  intent  of  the  law  that  they  shall  not  seek  large 
profits,  if  they  keep  a  larger  portion  of  cash  than  the  re- 
serve city  and  central  reserve  cities  have  done,  if  they  wisely 
use  the  power  to  issue  notes  at  the  same  time  meeting 
the  reasonable  demands  of  their  member  banks,  and  if 
they  cooperate  fully  with  the  Federal  Reserve  Board  in  ren- 
dering assistance  to  each  other,  the  proportion  of  the  de- 
posited reserve,  instead  of  being  a  snare,  should  now  be- 
come available  to  a  bank  when  needed.    The  countrv  bank, 


REDEPOSITING  OF  RESERVES  223 

whose  reserve  will  eventually  be  reduced  from  fifteen  to 
twelve  per  cent,  will  have  a  real  twelve  per  cent  reserve  as 
against  the  present  six  per  cent  reserve  which  it  has  in  its 
own  vaults,  and  upon  which  alone  in  times  of  stress  it  has 
been  able  to  count.  In  the  same  way  the  reserve  city  bank, 
whose  reserve  will  be  reduced  from  twenty-five  to  fifteen 
per  cent,  will  be  in  a  stronger  position,  because  the  twenty- 
five  per  cent  has  often  consisted  in  reality  only  of  the  twelve 
and  one-half  per  cent  of  cash  in  the  bank's  own  vaults. 
No  class  of  banlis  will  be  more  benefited  than  the  central 
reserve  city  banks,  whose  reserves,  while  reduced  from 
twenty-five  to  eighteen  per  cent,  have  nevertheless  been 
strengthened  more  than  those  of  any  other  class  of  banks. 
The  central  reserve  city  banks,  instead  of  having  roughly 
two  dollars  of  bankers'  demand  liability  for  each  dollar  of 
cash  which  they  hold,  will  now  be  relieved  entirely  of  these 
highly  combustible,  dangerous  deposits,  and  will  have  their 
entire  cash  available  for  the  protection  of  their  individual 
depositors. 

Reserves  on  Time  Deposits. — One  of  the  most  impor- 
tant changes  which  has  been  made  in  the  reserve  require- 
ments of  national  banks  and  such  State  banks  as  may  become 
members,  relates  to  savings  and  time  deposits.  The  Act 
specifies  that  "demand  deposits  within  the  meaning  of  this 
Act  shall  comprise  all  deposits  payable  within  thirty  days, 
and  time  deposits  shall  comprise  all  deposits  payable  after 
thirty  days  and  all  savings  accounts  and  certificates  of  de- 
posit which  are  subject  to  not  less  than  thirty  days'  notice 
before  payment."  It  is  impossible  to  state  accurately  the 
volume  of  time  deposits  as  defined  by  the  Act.  A  savings 
business  conducted  on  the  lines  of  savings  fund  societies 
organized  under  State  charter  is  not  specifically  authorized 
by  the  National  Bank  Act,  and  while  it  has  been  tolerated  by 
the  Comptroller  of  the  Currency,  it  has  nevertheless  been 
extra-legal.  The  national  banks  have  been  forced  by  the 
provisions  and  interpretation  of  the  National  Bank  Act  to 
pay  savings  deposits  upon  demand,  when  the  demand  has 
been   insistent.     The   result  has  been  that  manv  national 


224       OPERATION  OF  THE  NEW  BANK  ACT 


banks  which  have  accepted  savings  accounts  have  not  listed 
them  as  savings  deposits,  but  have  included  them  in  their 
statements  under  the  item  "individual  deposits  subject  to 
check. "  In  the  majority  of  cases  national  banks  have  adopted 
the  practice  of  giving  to  savings  depositors  time  certificates 
of  deposit,  which  are,  in  substance,  an  acknowledgment  of  in- 
debtedness on  the  part  of  the  bank,  with  an  agreement  to 
repay  the  customer,  upon  surrender  of  the  certificate,  the 
amount  stated  thereon  after  the  expiration  of  a  certain  num- 
ber of  days.  In  support  of  this  conclusion,  the  following  re- 
mark of  Senator  Nelson,  in  the  hearings  before  the  Senate 
Committee  on  Banking  and  Currency,  may  be  of  value :  "  I 
might  say  from  my  observation  in  the  West  that  while  the 
national  banks  have,  in  substance,  done  what  you  call  a  sav- 
ings-bank business,  they  have  done  it  in  the  form,  not  of  bank 
books,  but  of  time  certificates  of  deposit.  They  issue  time  cer- 
tificates of  deposit  drawing  interest  payable  in  six  or  nine 
months  or  a  j'ear,  with  the  condition  that  if  money  is  drawn 
out  before  the  specified  time,  they  lose  the  interest.  That  is 
the  way  most  of  the  little  countiy  national  banks  that  I  have 
observed  have  been  carrying  on  a  savings-deposit  business, 
but  the  funds  have  been  mixed  with  the  other  funds  of  the 
bank  and  utilized  in  the  same  way." 

Relative  Amount  of  Time  Deposits. — It  is  dangerous 
to  endeavor,  from  the  figures  of  the  Comptroller  of  the 
Currency,  to  place  any  estimate  upon  the  amount  of  time 
deposits  as  defined  in  the  Act.  However,  the  following 
figures  are  set  down  for  what  they  are  worth ;  in  all  likeli- 
hood they  understate  rather  than  overstate  the  amount  of 
time  deposits: 


Savings         1            Time 
deposits             certificates  of 
reported.        !         deposit. 

Total. 

$741,304,222.76    $463,386,351.24 

90,259,036.13         56,630,278.76 

1,166,827.58  '       14,382,478.18 

51,204,690,574.00 

Reserve  city  banks 

Central  reserve  city  banks.. 

146,889,314.89 
15,549,305.76 

Total 

$832,730,086.47  !  $534,399,108.18 

$1,367,129,194.65 

REDEPOSITING  OF  RESERVES  225 

The  remarkable  disparity  in  the  relative  amounts  of 
time  deposits  held  by  the  three  classes  of  banks  is  one  of  the 
most  interesting  features  of  the  present  banking  situation. 
The  central  reserve  city  banks,  heretofore  at  the  head  of  the 
banking  system,  held  less  than  $16,000,000  of  time  deposits, 
the  reserve  city  banks  held  approximately  $147,000,000, 
while  the  country  banks  held  the  staggering  total  of  over 
$1,200,000,000.  Roughly,  one-third  of  the  deposits  of  coun- 
try banks  are  made  up  of  time  deposits,  while  the  proportion 
of  deposits  of  central  reserve  banks  of  this  character  is  in- 
significant. The  explanation  of  the  large  amount  of  time 
deposits  held  by  the  country  banks  is  to  be  found  in  the 
conditions  under  which  they  do  business.  In  the  agricul- 
tural districts  the  savings  banks  are  not  nearly  as  numerous, 
nor  do  they  have  as  strong  a  hold  upon  a  community,  as  in 
the  manufacturing  towns  of  New  Eugland  or  in  the  large 
cities. 

Character  of  National  Banks'  Savings  Deposits. — A 
very  considerable  proportion  of  the  savings  accounts  in 
the  towns  and  smaller  cities  are  not  of  the  conventional 
order,  but  are  an  outgrowth  of  the  commercial  banking 
business  of  the  institutions.  Customers  open  savings 
accounts  for  their  wives  and  children,  or  perhaps  open  a 
special  savings  account  in  which  to  deposit  surplus  funds, 
using  for  the  purpose  the  surplus  in  their  ordinary  checking 
accounts,  which  will  not  be  needed  for  some  mouths.  In 
other  words,  the  savings  business  is  an  allied  business ;  and 
under  such  circumstances  the  customer  is  very  willing  to 
take  a  time  certificate  of  deposit,  paiUcularly  when  by  so 
doing  he  can  secure  higher  interest  than  he  could  if  he 
insisted  upon  keeping  his  funds  in  such  a  manner  that  he 
could  check  against  them  at  any  time. 

Looked  at  from  a  banking  stand-point,  there  is  no  reason 
why  as  large  a  reserve  should  be  held  against  these  savings 
accounts  as  against  checking  accounts.  This  is  true  whether 
they  consist  of  money  in  an  ordinary  savings  department, 
or  of  time  certificates  of  deposit.  Savings  accounts  are 
much  more  stable,  and  oxperionco  has  shown  tlmt  the  with- 
15 


226       OPERATION  OF  THE  NEW  BANK  ACT 

drawals  are  exceedingly  regular.  The  result  is  that  the 
bank  can  not  only  keep  with  safety  a  much  lower  reserve, 
but  the  balance  can  be  invested  in  assets  of  a  sort  not  as 
quickly  convertible  into  cash  as  would  be  demanded  by  the 
necessities  of  the  ordinaiy  checking  business. 

Reduction  of  Reserves  on  Time  Deposits. — The  reduc- 
tion of  the  cash  reserve  against  such  of  the  business  of  the 
national  bank  as  represents  deposits  notwithdrawable  within 
thirty  days,  from  the  old  requirement  of  from  fifteen  to 
twenty-five  per  cent  to  the  new  basis  of  five  per  cent,  will 
make  a  vast  difference  in  the  amount  which  our  national 
banks  must  keep  on  hand,  and  in  the  amount  they  may 
deposit  with  reserve  agents. 

If  we  take  the  country  banks  as  an  illustration,  we  find 
that  they  were  required  heretofore  to  carry  against  their 
$1,204,000,000  of  savings  deposits,  a  reserve  of  $180,600,000, 
partly  in  their  own  vaults,  and  partly  on  deposit  with  their 
reserve  agents.  Under  the  new  law,  the  reserve  required 
upon  the  savings  business  will  be  reduced  to  $60,200,000. 
Whether  the  country  banks  will  see  fit  to  take  advantage  of 
the  reduction  permitted  by  the  new  law,  must  be  considered 
fully  when  we  have  finished  our  inquiry  relative  to  the 
conditions  underlying  reserves. 

In  readjusting  the  reserve  requirements  of  the  national 
banks.  Congress  was  faced  with  a  difficult  problem.  It  was 
generally  admitted  that,  with  a  more  perfect  system,  lower 
reserves  could  be  safely  established;  but  how  much  lower 
the  reserves  should  be,  to  what  degree  they  should  consist  of 
cash  in  the  bank 's  vaults,  and  the  amount  by  which  the  de- 
posit vtdth  the  reserve  agents  should  be  reduced,  was  a  matter 
upon  which  nothing  but  opinions  could  be  secured.  One 
would  suppose  that  foreign  experience  would  be  of  some 
value,  but,  unfortunately,  little  help  could  be  secured  from 
that  source.  Abroad  the  reseiwes  which  the  banks  carr^-  can 
be  very  much  smaller  than  would  be  required  in  this  country, 
because  of  the  difference  in  the  character  of  the  business 
which  they  conduct.  The  practice  of  borrowing  on  commer- 
cial paper  for  the  purpose  of  discounting  bills,  or  of  financ- 


REDEPOSITING  OF  RESERVES  227 

ing  the  purchase  and  sale  of  commodities,  is  comparatively 
rare.  The  greater  proportion  of  trade  is  financed  by  drafts, 
with  a  life  of  from  seven  to  fifteen  days.  This  furnishes  a 
tremendous  volume  of  short-time  paper,  certain  to  be  liqui- 
dated upon  maturity,  and  of  the  very  choicest  character  for 
rediscounting  at  the  central  institution.  Under  these  con- 
ditions, the  joint  stock  banks  in  London,  which  correspond 
roughly  to  our  member  banks,  have  found  it  sufficient  to 
carry  a  reserve  averaging  about  three  and  one-half  per  cent ; 
while  in  Germany  such  institutions  have  inin  along  for  con- 
siderable periods  with  cash  reserves  in  their  own  vaults 
averaging  about  one  per  cent.  It  is  true  that  considerable 
agitation  has  arisen  in  England  and  Germany  to  require 
joint  stock  banks  to  keep  larger  reserves,  on  the  ground  that 
too  great  a  strain  is  placed  on  the  Bank  of  England  and  on 
the  Reichsbank,  respectively,  and  that  the  persistent  follow- 
ing of  this  course  will  bring  the  banks  to  financial  disaster. 
It  is  evident,  however,  that  the  conditions  are  so  dissimilar 
abroad  that  it  would  not  be  safe  for  us  to  copy  their  practice. 
Abolition  of  Deposited  Reserves. — The  almost  unani- 
mous view  of  the  bankers,  who  appeared  before  the  Congres- 
sional committees,  or  who  expressed  themselves  concerning 
currency  reform,  was  that  an  indispensable  feature  of  the 
plan  must  be  the  removal  of  a  considerable  part  of  the 
deposited  reserves  from  the  national  banks  to  the  new 
regional  banks.  When  this  point  was  passed,  a  wide  differ- 
ence of  opinion  developed.  The  divergence  in  the  views 
of  bankers  concerns  two  main  problems :  first,  the  number 
of  centers  into  which  the  mobilization  of  bank  reserves 
should  be  effeetod,  and  second,  the  proportion  of  the  reserves 
of  the  banks  which  should  be  mobilized.  The  first  question, 
relating  to  the  degree  of  concentration  of  the  reserves  to  be 
turned  over  to  the  Federal  banks,  is  intimately  related  to  the 
problem  of  whether  it  would  be  better  to  have  a  central  insti- 
tution with  branches,  such  as  proposed  in  the  Aldrich  plan  : 
a  few  large  institutions,  say  three  or  four  in  number,  such  as 
was  proposed  by  the  majority  of  the  bankers  of  New  York 
ajid  other  large  cities;  or  whether  it  would  be  more  desirable 


228       OPERATION  OF  THE  NEW  BANK  ACT 

to  have  eight  to  twelve  districts,  in  which  the  reserves  should 
be  mobilized. 

Regional  System  and  the  Reserve  Problem. — From 
many  points  of  view,  the  problem  of  the  nimiber  of  reserve 
banks  is  the  problem  of  the  concentration  of  reserves.  We 
have  already  revieAved  the  advantages  and  disadvantages  of 
the  three  systems  suggested  above,  and  have  seen  the  appli- 
cability of  each  system  to  American  conditions.  It  is,  of 
course,  obvious  to  any  one  that  the  mobilization  of  all  of 
the  reserves  into  one  vault,  belonging  to  a  central  bank, 
would  be  highly  inexpedient.  It  would  be  of  no  advantage 
to  a  bank  in  San  Francisco,  which  suddenly  needed  help, 
to  be  able  to  call  upon  the  concentrated  reserves  of  the  coun- 
try contained  in  a  vault  in  New  York  or  AVashington.  The 
six  days  of  time  which  would  be  required  to  ship  the  cur- 
rency across  the  country  would  probably  measure  the  ruin 
of  the  needy  institution.  As  a  matter  of  fact,  no  banker 
has  proposed  the  actual  physical  concentration  of  reserves 
into  one  center.  Even  the  strongest  advocates  of  the  central 
bank  have  taken  the  position  that  there  should  be  a  number 
of  points,  for  the  sake  of  illustration  say  fifteen  in  number, 
as  under  the  Aldrich  plan,  at  which  the  reserves  of  the  coun- 
try should  be  mobilized.  The  chief  argument  in  support  of 
the  central  bank  as  a  possible  solution  of  the  reserve  prob- 
lem is  that  the  reserve  in  each  of  these  fifteen  stations  is 
under  the  control  of  the  central  bank  or  reserve  association, 
which  has  absolute  power  over  its  distribution  and  can  ship 
money  from  one  point  to  another  as  needed.  So  with  fifteen 
stations,  it  would  be  possible,  should  a  panic  develop  in 
three  of  them,  to  draw  funds  from  the  remaining  twelve  for 
the  assistance  of  those  in  trouble.  The  control  of  the  central 
bank  over  its  branches  would  be  absolute.  There  would  be 
no  red  tape,  no  necessity  of  consulting  local  interests,  and 
no  delay,  such  as  would  be  involved  in  calling  meetings  of 
directors  of  regional  banks  and  submitting  plans  for  the 
transfer  of  part  of  their  funds  to  some  other  reserve  bank. 

These  arguments  are  very  strong  and  have  compelled 
great  respect.    Looked  at  from  another  stand-point,  however, 


REDEPOSITIXG  OF  RESERVES  229 

we  must  recognize  the  fact  that  agaiust  these  advantages  are 
the  drawbacks  which  have  already  been  outlined  as  incident 
to  the  central  bank  plan.  Moreover,  it  is  doubtful  whether 
the  advantages  are  as  great  as  might  appear  at  first  glance. 
With  a  central  institution  the  temptation  would  be  to  draw 
the  reserves  away  from  some  of  the  districts  and  concentrate 
them  in  others,  and  this  movement  would  be  prompted  per- 
haps not  so  much  by  a  desire  to  strengthen  the  banking 
situation  of  the  country  as  a  whole,  as  to  take  advantage  of 
the  greater  opportunities  for  profit  which  might  be  found 
at  other  points. 

Central  Bank  and  the  Reserve  Problem. — In  brief,  it 
has  been  very  strongly  urged  that  the  creation  of  a  central 
bank  would  mean  the  continuation  of  existing  conditions, 
by  which  the  reserves  of  the  country  have  drifted  into  one 
or  two  points,  particularly  into  New  York  City.  The  experi- 
ence of  the  past  would  seem  to  indicate  that  such  a  tendency 
is  vicious. 

We  need  not,  at  this  point,  completely  review  the  argu- 
ments for  and  against  the  central  bank.  The  question  as  to 
whether  or  not  each  of  the  regional  banks  to  be  established 
by  the  new  law  can  stand  by  itself  is  also  one  which  we  have 
already  considered.  But  since  the  larger  proportion  of  the 
assets  of  the  regional  banks  consists  of  the  reserve  deposits 
with  them  of  the  member  banks,  this  problem  necessarily 
presents  itself  again  in  the  consideration  of  the  question 
of  the  reserve  of  the  member  bank.  Suffice  it  to  say  in  con- 
clusion, that,  in  the  long  run,  in  a  time  of  panic  the  amount 
of  aid  that  either  a  central  bank  or  a  number  of  regional 
banks  can  give  is  a  matter  of  proportion ;  for  the  degree  of 
aid  will  be  measured  by  the  proportion  of  the  deposits  which 
have  been  placed  by  each  bank  with  the  central  institution 
or  with  the  regional  bank.  If  eveiy  bank  should  need  help, 
which  is  an  inconceivable  thing,  the  system  is  bound  to 
fail.  The  more  we  can  localize  our  difficultios,  the  better  it 
will  be  for  the  country,  provided  the  region  in  distress  can 
secure  prompt  and  efficient  aid  from  those  districts  not 
suffering  a  similar  misfortune.    Whether  or  not  the  regional 


230       OPERATION  OF  THE  NEW  BANK  ACT 

banks  will  help  each  other  hi  times  of  stress  is  a  matter 
which  can  be  determined  only  by  experience.  The  problem 
is  one  largely  dependent  upon  the  personal  equation :  Will 
the  directors  of  the  several  regional  banks  recognize,  as  the 
directors  of  the  central  banks  in  Europe  have  done,  that 
the  best  policy  is  to  stamp  out  a  panic  wherever  it  appears 
by  every  bank  going  to  the  aid  of  the  one  in  distress ;  or  will 
they  take  a  narrow,  insular  view  of  their  obligations  and 
refuse  to  help,  on  the  ground  that  to  do  so  would  imperil 
their  constituent  banks  ?  We  must  remember  that  the  Fed- 
eral Reserve  Board  possesses  wide  powers  in  this  direction, 
and  that  if  it  is  composed  of  able,  alert  men  it  can  do  much 
to  check  such  a  narrow,  short-sighted  policy,  should  it  arise, 
and  may  actually  prevent  its  ever  arising. 

The  Proposal  for  Three  Regional  Reserve  Centers. — 
Many  bankers  have  advocated  a  system  comprising  three 
regional  banks,  basing  their  arguments  entirely  upon  the 
matter  of  reserves  and  the  collection  of  checks  and  other 
cash  items.  These  gentlemen  argue,  with  considerable  force, 
that  violently  to  uproot  our  present  system,  by  which  the 
funds  of  the  country  are  carried  largely  in  New  York, 
Chicago  or  St.  Louis,  will  work  serious  disturbance.  Unless 
there  are  strong  reasons  to  make  such  a  step  necessary,  the 
plan  for  a  greater  number  of  regional  banks  is  ill-advised. 
It  is  their  contention  that  if  we  should  create  a  regional 
bank  in  each  of  the  three  central  reserve  cities  to  which  the 
reserve  cities  could  turn  for  rediscounts  in  times  of  stress, 
or  if  we  should  expand  the  functions  of  the  clearing  houses, 
giving  them  the  right  to  rediscount  and  issue  notes  against 
these  rediscounts,  we  would  solve  the  problem  with  which 
the  nation  is  confronted.  It  would,  in  either  event,  be 
unnecessary  to  effect  any  radical  readjustment  of  the  cash 
reserves;  to  disturb  the  present  relations  of  the  country 
and  reserve  city  banks  with  each  other  and  with  the  central 
reserve  institutions ;  to  disarrange  the  methods  of  collection 
and  of  handling  the  exchange  business  of  the  country,  which 
is  the  result  of  years  of  development ;  or  to  make  any  other 


REDEPOSITING  OF  RESERVES  231 

violent  change  whatsoever  which  might  disturb  business 
and  create  financial  trouble. 

Moreover,  a  powerful  argument  in  support  of  this  view 
is  that  such  a  regional  institution  would  be  very  much  larger, 
and  hence  more  powerful,  than  the  eight  or  twelve  estab- 
lished under  the  Reserve  Act,  and,  therefore,  its  ability  to 
help  in  times  of  stress  would  be  very  much  greater.  This 
contention,  however,  in  order  to  be  valid,  must  take  for 
granted  that  the  larger  community  will  not  have  the  same 
relative  demands  from  its  constituent  banks,  that  the  pres- 
sure will  come  almost  entirely  from  the  central  reserve  cities, 
and  that,  therefore,  commanding  a  wider  territory  for  each 
central  reserve  city,  the  reserve  bank  will  be  in  a  much 
stronger  position  to  help  the  beleaguered  spot. 

Concerning  the  second  general  point  of  difference,  which 
is  whether  or  not  it  is  advisable  to  take  the  entire  reserves 
out  of  the  present  reserve  centers,  an  equally  wide  divergence 
of  opinion  was  developed.  In  order  to  understand  the  dis- 
cussion, it  should  be  emphasized  at  this  point  that  the  pro- 
visions of  the  Federal  Reserve  Act,  in  general,  require  the 
transfer  from  their  present  reserve  agents  to  the  Federal  re- 
serve banks  by  graduated  stages,  over  a  space  of  three  years, 
of  the  entire  reserves  not  held  in  the  vaults  of  the  member 
banks.  That  is  to  say  each  member  bank  is  compelled  to 
keep  its  required  reserve  in  one  of  two  places,  either  in  its 
own  vaults  or  in  the  vaults  of  its  Federal  reserve  bank.  The 
law  does  not  prohibit  the  bank  from  keeping  deposits  with 
other  banks,  but  simply  specifies  that  such  deposits,  if  kept, 
shall  not  be  counted  as  part  of  the  reserve  of  the  depositing 
bank. 

It  was  not  to  be  expected  that  the  reserve  and  central 
reserve  city  banks  would  give  up  without  a  struggle  their 
country  deposits, — which  roughly  aggregate,  one  city  with 
another,  one-half  of  their  totals.  It  has  required  years  of 
effort  and  millions  of  dollars  of  outlay  to  build  up  these 
deposits.  The  bankers  and  many  of  the  business  men  of  the 
reserve  centers  have  argued  that  this  money  would  largely 
be  idle  if  moved  to  other  points;  that  it  was  being  used  to 


232       OPERATION  OF  THE  NEW  BANK  ACT 

finance  the  commerce  of  the  nation  in  its  present  location; 
that  it  was  following  the  regular  channels  of  trade;  that 
upon  it  the  commercial  and  financial  welfare  of  the  cities  de- 
pends; and  that  they  had  developed  business  upon  the  faith 
of  these  funds,  the  withdrawal  of  which  would  be  grossly 
unfair,  and  inimical  to  the  best  interests  of  the  nation. 

What  Proportion  of  Present  Reserve  Balances  Should 
Be  Withdrawn. — Practically  speaking,  no  one  proposed 
that  the  present  deposits  with  reserve  agents  should  be  kept 
intact.  It  was  conceded  by  all  that  the  reserve  banks  should 
carry  a  part  of  the  reserve  of  the  member  institutions.  The 
question  which  remained  for  settlement  was  how  the  reserve 
not  carried  in  the  member  banks'  vaults  should  be  divided 
between  the  reserve  banks  and  the  present  reserve  agents. 
From  the  first  draft  the  Federal  Reserve  Act  has  provided 
that  the  entire  reserves,  other  than  the  portions  kept  in  the 
member  banks '  vaults,  should  be  carried  in  the  vaults  of  the 
Federal  reserve  banks.  The  efforts  of  the  bankers  have 
been  to  secure  a  modification  of  this  provision,  and  have 
been  entirely  unsuccessful. 

Proposals  of  Country  Banks  concerning  Reserves. — 
Generally  speaking,  the  modification  which  they  desired  was 
to  split  the  portion  of  the  reserve  not  carried  in  the  banks' 
vaults,  between  the  present  reserve  agents  and  the  Federal 
reserve  banks,  according  to  the  proportion  which  appealed 
to  each  particular  banker.  Mr.  A.  J.  Frame,  for  example, 
advocated  that  a  sum  equal  to  five  per  cent  of  the  deposits 
of  the  member  banks, — that  is  to  say,  from  one-third  to  one- 
fifth  of  the  total  reserves  of  the  national  banks, — should 
be  transferred  from  present  reserve  agents  to  the  Federal 
reserve  banks.  The  so-called  "country  banks"  at  the  con- 
vention of  the  American  Bankers'  Association  at  Boston, 
held  while  the  bill  was  pending  before  Congress,  adopted  a 
series  of  resolutions  in  which  it  was  declared,  "that  whatever 
percentage  of  reserves  is  agreed  upon,  should  carry  with  it 
the  right  to  keep  not  less  than  one-third  of  such  reserve  with 
approved  reserve  agents  and  fiscal  centers. ' ' 

The  reasons  advanced  in  support  of  these  arguments 


REDEPOSITING  OF  RESERVES  233 

were:  (1)  that  the  new  Act  would  not  relieve  the  member 
banks  from  the  necessity  of  carrying  balances  with  their 
reserve  agents,  these  balances  being  necessary  to  enable  the 
country  banks  to  sell  exchange  and  handle  their  collections. 
It  was  pointed  out  that  at  the  present  time  many  bankers 
found  it  necessary  to  keep  balances  with  institutions  so  situ- 
ated, and  that,  under  the  law,  these  balances  could  not  be 
counted  as  a  part  of  their  reserves,  (2)  That  such  a  great 
concentration  was  unnecessary  and  inadvisable;  and  that 
even  though  it  were  advisable,  an  absolute  requirement  in 
the  statute  might  work  great  hardship,  because  conditions 
might  so  change  as  to  precipitate  a  panic  before  the  enforced 
shifting  occurred.  It  would  be  better  to  start  with  a  small 
per  cent,  and  then,  if  necessary,  to  shift  a  larger  proportion 
later  on.  The  last  of  these  two  arguments  is,  in  substance,  the 
same  as  that  already  discussed  in  examining  the  question  as 
to  whether  any  portion  of  the  banks'  reserve  should  be  left 
with  the  reserve  agent.  The  only  point  Avhich  needs  extended 
consideration  is  the  first:  Will  a  bank  be  required  to  keep 
balances  with  its  present  reserve  agent,  irrespective  of  the 
provisions  of  the  Reserve  Act,  in  order  to  handle  its  exchange 
and  collection  business? 

It  is  difficult  to  express  any  intelligent  opinion  upon  this 
point.  The  only  reason  why  a  bank  should  keep  such  bal- 
ances is  for  the  handling  of  collections  and  for  the  incidental 
work  of  selling  exchange  to  its  customers.  The  degree  to 
which  this  necessity  will  continue  depends  directly  upon  the 
success  with  which  the  regional  banks  meet  in  developing 
their  clearing  functions.  One  of  the  important  servjces 
which  the  framers  of  the  Act  expect  the  Federal  reserve 
banks  to  perform,  is  to  do  what  the  clearing  house  does  for 
its  members.  According  to  the  law,  member  l)anks  may 
deposit  checks,  drafts  and  bills  of  exchange  with  the  Federal 
reserve  bank,  thus  putting  upon  it  the  work  of  collecting 
these  items.  Member  banks  may  also  draw  drafts  upon  the 
Federal  reserv'e  bank,  which  drafts,  it  is  expected,  will  have 
as  great  currency  as  do  the  present  drafts  drawn  by  banks 
upon  their  New  York  or  other  reserve  depositories.     It  is 


\ 


234       OPERATION  OF  THE  NEW  BANK  ACT 

necessary,  however,  to  defer  extended  consideration  of  the 
question  of  the  clearing  functions  of  ■  reserve  banks  until 
a  later  chapter. 

Objections  to  Fixing  Absolute  Limits  in  Readjusting 
Reserves. — The  objection  to  the  requirement  of  the  Reserve 
Act  fixing  absolute  dates  by  which  time  transfer  of  the 
reserves  from  the  present  reserve  agents  to  the  Federal  re- 
serve banks  must  be  effected,  loses  some  of  its  force  when 
it  is  remembered  that  the  law  specifies  that  the  transfer  must 
be  made  within  a  certain  period,  and  not  on  any  given  date. 
It  is,  of  course,  evident  that  if  a  large  amount  of  money 
were  suddenly  to  be  shifted  from  the  present  reserve  agents 
to  Federal  reserve  banks  at  a  time  of  great  financial  strin- 
gency, the  operation  would  be  attended  with  a  great  deal  of 
peril  to  the  country.  However,  business  is  not  largely  ex- 
tended, and  the  banks  have  had  ample  warning  of  the  im- 
pending change  and,  to  a  large  degree,  have  prepared  them- 
selves for  it  by  a  cautious  lending  policy.  How  great  this 
strain  will  be  under  the  best  conditions  and  how  severe  it 
might  be  under  adverse  conditions  we  can  consider  intelli- 
gently only  after  we  have  examined  in  detail  the  amount 
of  money  which  must  be  shifted  and  the  changes  which  the 
shift  will  bring. 

The  Question  of  a  Fixed  Minimum  Reserve. — Some 
question  might  be  raised  as  to  the  wisdom  of  the  policy 
expressed  by  the  Act  in  requiring  a  fixed  minimum  reserve. 
This  is  a  continuation  of  the  policy  which  has  prevailed 
during  the  last  fifty  years  and  which  has  been  tried  in  prac- 
tically every  State.  Abroad,  the  institution  of  a  reserve 
fixed  absolutely  by  law  is  comparatively  unknown.  The 
banks  are  left,  to  a  large  degree,  to  keep  such  reserve  as  in 
their  judgment  is  necessary;  and  it  is  urged  that  such  a 
plan  is  the  only  true  principle  of  good  banking  and  that  the 
American  practice  is  vicious.  The  question  of  reserves  is, 
to  a  large  degree,  a  psychological  problem.  One  of  the  chief 
purposes  of  keeping  a  reserve  is  to  keep  public  confidence, 
and  the  standards  of  public  confidence  are  fixed  largely  by 
the  conditions  which  have  heretofore  existed.    The  proposal 


REDEPOSITING  OF  RESERVES  235 

on  the  part  of  the  bauks  that  they  be  allowed  to  keep  any 
reserve  they  might  wish  would  call  forth  almost  universal 
denunciation  from  the  American  public  at  large.  We  have 
become  accustomed  to  a  fixed  reserve,  and  it  would  therefore 
have  been  a  grave  mistake  to  incorporate  into  the  new  Cur- 
rency xVct  a  provision  which  would  bring  popular  distrust 
upon  the  new  system.  On  the  other  hand,  the  fixed  reserve 
does  carry  with  it  serious  objections.  If  the  reserve  of  a 
bank  runs  below  its  legal  limit,  the  fact  becomes  known 
through  a  public  statement  or  in  a  mysterious  underground 
fashion  which  is  one  of  the  most  inexplicable  things  in  banli- 
ing.  The  fact  that  the  reserve  has  run  below  the  legal  limit 
turns  suspicion  into  positive  distrust,  swells  the  abnormal 
withdrawals  into  a  run,  and,  unless  aid  is  promptly  forth- 
coming, destroys  the  bank. 

Even  though  we  accept  as  correct  the  criticism  that  the 
American  banker  has  persistently  misinterpreted  the  law, 
construing  it  as  a  command  to  keep  a  certain  definite  reserve 
and  no  more,  which  has  unfortunately  been  the  case  in  the 
reserve  and,  more  especially,  in  the  central  reserve  cities, 
the  fact  remains  that,  from  the  stand-point  of  the  ability  of 
the  bank  to  withstand  a  shock,  the  fixed  reserve  is  a  handicap. 
Under  the  new  system  this  handicap  is  not  likely  to  be  as 
serious  as  it  has  proved  in  the  past,  for  the  member  bank 
can  withdraw  from  the  Federal  reserve  bank  any  surplus 
above  the  legal  minimum  which  it  may  have  on  deposit  there, 
and  if  this  proves  insufficient,  may  discount  its  eligible 
paper.  Thus,  so  long  as  the  Federal  reserve  bank  is  able  to 
meet  the  withdrawals  of  its  members,  there  is  no  excuse  for 
a  bank  which  has  been  honestly  and  wisely  managed  having 
its  reserve  fall  seriously  below  the  legal  minimum. 

Conditions  under  Which  Reserves  Can  Be  Reduced 
below  Minimum. — In  order  to  make  assurance  doubly  sure, 
however,  the  Federal  Reserve  Act  meets  the  criticism  con- 
cerning a  fixed  reserve  by  eliminating  the  extremely  severe 
penalties  which  were  provided  by  the  National  Bank  Act 
for  the  violation  of  the  reserve  requirement,  through  the 
insertion  of  a  clause  which  gives  to  the  Federal  Reserve 


236       OPERATION  OF  THE  NEW  BANK  ACT 

Board  the  right  "to  suspend  for  a  period  not  exceeding 
thirty  days,  and  from  time  to  time  to  renew  such  sus- 
pension for  periods  not  exceeding  fifteen  days,  any  re- 
serve requirements  specified  in  this  Act :  Provided,  That  it 
shall  establish  a  graduated  tax  upon  the  amounts  by  which 
the  reserve  requirements  of  this  Act  may  be  permitted  to 
fall  below  the  level  hereinafter  specified." 

The  problem,  if  there  is  one,  largely  concerns  the  Federal 
reserve  banks.  These  institutions,  as  we  have  seen,  are 
required  to  keep  reserves  of  gold  or  legal  tender  of  not  less 
than  thirty-five  per  cent  against  their  deposits ;  and  reserves 
of  gold  of  not  less  than  forty  per  cent  against  Federal  re- 
serve notes  in  actual  circulation  and  not  offset  by  gold  or 
lawful  money  deposited  with  a  Federal  reserve  agent.  It  is, 
of  course,  probable  that  in  order  to  satisfy  these  regulations 
the  Federal  reserve  bank  will  set  off  its  gold  to  a  large  degree 
against  its  circulating  notes.  To  the  lending  bank  it  makes 
little  difference  whether  the  demand  for  funds  is  met  by 
shipments  of  gold  or  of  legal  tender ;  but  inasmuch  as  it  is 
altogether  probable  that  a  widespread  movement  of  redis- 
counting  would  sooner  or  later  force  the  Federal  reserve 
bank  to  issue  reserve  notes,  it  will  take  great  caution  to 
make  sure  that  it  can  command  a  sufficient  amount  of  gold 
to  enable  it  to  meet  the  requirements  of  the  law,  even  though 
it  should  take  advantage,  in  extreme  cases,  of  the  provision 
permitting  it  to  run  down  this  reserve  against  its  circulation 
by  paying  the  required  tax. 

Inability  to  Use  Federal  Reserve  Notes  for  Reserves. — 
This  problem  is  very  similar  to  that  which  confronts  the 
central  banking  institutions  of  every  foreign  nation,  and  the 
successful  solution  of  the  question  depends  to  a  large  degree 
upon  the  character  of  the  management  of  the  Federal  re- 
serve banks.  A  feature  of  the  Act  which  deserves  considera- 
tion is  the  fact  that  the  Act  does  not  permit  the  member 
banks  to  count  the  Federal  reserve  notes  as  a  part  of  their 
cash  in  figuring  their  reserve.  In  other  words,  these  notes 
occupy  the  same  position  as  do  the  national  bank  notes  at  the 
present  time. 


REDEPOSITIXG  OF  RESERVES  237 

The  problem  concerning  the  Federal  reserve  notes,  how- 
ever, is  somewhat  different  from  that  prevailing  in  the 
case  of  the  national  bank  notes.  As  the  business  of  the 
country  expands,  the  amount  of  Federal  reserve  notes  which 
will  be  issued  will,  in  all  probability,  steadily  increase,  and 
the  proportion  of  the  legal  tender  money  to  the  total  amount 
of  money  in  circulation  will  be  correspondingly  reduced. 
This  tendency  can  be  averted  only  by  a  consistent  and  bril- 
liantly executed  policy  of  expanding  the  gold  reserve  as  the 
banking  business  of  the  country  grows.  If  it  should  tran- 
spire that  the  proportion  of  legal  tender  and  specie  to  the 
total  amount  of  money  in  circulation  should  decrease,  then 
it  is  inevitable  that  both  the  member  banks  and  the  Federal 
reserve  banks  will  have  greater  ditificulty  in  preserving  their 
cash  reserve.  It  is  very  possible  that  the  situation  might  be- 
come so  aggravated  that  the  Federal  reserve  bank  would  be 
seriously  embarrassed  in  getting  its  notes  into  circulation  be- 
cause of  the  fact  that  member  banks  would  call  for  gold  or 
legal  tender,  as  they  have  the  right  to  do,  in  return  for  the 
rediscounts  or  for  the  surplus  reserve  which  they  might  then 
be  carrying  with  the  Federal  reserve  banks.  This  would, 
to  a  large  degree,  vitiate  the  whole  plan ;  but,  on  the  other 
hand,  it  would  powerfully  impress  the  reserve  banks  with 
the  necessity  of  strengthening  their  position.  This  is  desir- 
able because  it  would  insure  a  larger  gold  reserve  for  the 
country. 

Will  Interest  Be  Paid  on  Reserve  Balances? — The 
question  of  the  payment  of  interest  upon  the  deposits  of 
member  banks  with  the  Federal  reserve  banks  is  one  which 
will  likely  be  strongly  impressed  upon  the  attention  of  the 
Federal  Reserve  Board  and  the  directors  of  the  reserve  banks 
shortly  after  their  organization  is  completed.  We  have  seen 
that,  in  the  case  of  a  large  number  of  banks,  the  payment  of 
interest  upon  reserve  balances  is  a  vicious  practice  because 
it  forces  the  drawing  down  of  the  cash  holdings  of  the  bank 
itself  by  requiring  it  immediately  to  put  this  money  at  work 
in  a  manner  which  will  earn  the  interest  and  the  cost  of 
handling  it.    This  leads  to  an  undue  depletion  of  the  reserve 


238       OPERATION  OF  THE  NEW  BANK  ACT 

institution,  forcing  it  down  toward  the  legal  minimum, 
whereas  it  should  be  carrjang  a  large  reserve  to  meet  any 
contingency  which  arises.  It  is  contended  that  the  payment 
of  interest  would,  to  a  large  degree,  overturn  the  whole  plan. 
It  would  reduce  the  reserve  bank  to  the  level  of  the  common- 
place bank,  seeking  to  make  profits  for  the  member  banks, 
its  stockholders,  through  the  payment  of  interest ;  and  in  this 
manner  the  plain  intent  of  the  law,  which  was  to  limit  the 
profits  which  the  member  banks  could  draw  from  their  in- 
vestment in  the  reserve  bank,  would  be  evaded. 

The  pajTuent  of  interest  under  certain  circumstances, 
however,  may  conceivably  be  desirable.  If  it  should  trans- 
pire that  the  demands  upon  the  Federal  reserve  banks  are 
so  heavy  that  their  resources  would  be  taxed  to  the  limit,  and 
if,  at  the  same  time,  the  member  banks  should  keep  their 
deposits  down  to  the  minimum,  it  might  be  wise  for  the 
reserve  banks  to  strengthen  their  position  by  increasing 
deposits  through  this  device. 

If,  on  the  other  hand,  it  should  appear  that  the  Federal 
reserve  banks  will  not  have  unusual  demands  made  upon 
them,  it  will  be  most  unfortunate  if  they  adopt  a  policy  of 
paying  interest,  for  this  will  inevitably  influence  their  direc- 
tors in  the  management  of  these  institutions.  A  factor 
which  will  be  seriously  considered  by  the  State  banks  in 
determining  whether  to  accept  the  Federal  Eeserve  Act  and 
subscribe  to  the  stock  of  the  regional  banks  will  be  this  ques- 
tion of  the  payment  of  interest  upon  their  reserve  accounts. 
So  long  as  it  is  possible  for  the  State  banks  to  deposit  their 
funds  with  their  depositories  in  the  reser\^e  and  central 
reserve  cities  (these  depositories  being  in  all  probability 
member  banks  under  the  Reserve  Act),  it  will  be  difficult 
to  convince  them  that  by  becoming  members  of  the  Federal 
reserve  banks  and  carrying  their  funds  on  deposit  there 
they  will  gain  more  than  the  loss  of  the  two  per  cent  interest 
which  they  now  receive.  The  only  advantage  which  might 
offset  this,  loss  would  be  the  better  service  which  they  could 
render  their  customers  by  means  of  the  superior  collection 
facilities  through  the  Federal  reserve  banks,  and  the  extent 
of  this  advantage  is  by  no  means  clear  at  this  time.  The  law 


REDEPOSITING  OF  RESERVES  239 

has  endeavored  to  meet  the  objections  of  the  State  bankers 
in  part  by  the  following  provision : 

"  If  a  State  bank  or  trust  company  is  required  by  the  law 
of  its  State  to  keep  its  reserves  either  in  its  own  vaults 
or  with  another  State  bank  or  trust  company,  sueh  reserve 
deposits  so  kept  in  such  State  bank  or  trust  company  shall 
be  construed,  within  the  meaning  of  this  section,  as  if  they 
were  reserve  deposits  in  a  national  bank  in  a  reserve  or 
central  reserve  city  for  a  period  of  three  years  after  the 
Secretary  shall  have  officially  announced  the  establishment 
of  a  Federal  reserve  bank  in  the  district  in  which  such  State 
bank  or  trust  company  is  situate.  Except  as  thus  provided, 
no  member  bank  shall  keep  on  deposit  with  any  uoumember 
bank  a  sum  in  excess  of  ten  per  centum  of  its  own  paid-up 
capital  and  surplus.  No  member  bank  shall  act  as  the 
medium  or  agent  of  a  nonmember  bank  in  applying  for  or 
receiving  discounts  from  a  Federal  reserve  bank  under  the 
provisions  of  this  Act  except  by  permission  of  the  Federal 
Reserve  Board." 

This  clause  is  designed  to  put  the  State  banks,  during 
the  transition  stage,  upon  the  same  basis  as  the  national  insti- 
tutions. It  does  not  prevent  them  from  carrying  the  same 
reserve  with  present  reserve  agents  as  may  national  banks 
doing  the  same  business.  To  what  degree  this  solves  the 
objection  of  the  State  banks  and  how  far  they  may  go  under 
the  laws  of  the  several  States  to  meet  the  terms  of  this 
section  of  the  Act,  must  be  left  for  consideration  in  a  later 
chapter. 

Wisdom  of  Carrying  Liberal  Surplus  Reserve. — As  a 
general  proposition,  it  is  to  be  hoped  that  the  Federal  re- 
serve banks  and  the  Federal  Reserve  Board  will  use  their 
influence  and  counsel  to  induce  the  member  banks  to  carry 
a  liberal  cash  reserve  both  in  their  own  vaults  and  on  deposit 
with  their  reserve  agents,  so  that  all  of  the  strain  of  main- 
taining elasticity  and  of  guarding  against  financial  trouble 
may  not  be  thrown  upon  tlie  reserve  institutions,  and  so  that 
the  member  banks  may  keep  themselves  in  position  to  handle 
the  probable  needs  of  their  communities  without  depending 
too  much  upon  the  reserve  banks. 


CHAPTER  XXII 
Readjustment  of  the  Reserves  in  the  Country  Banks 

Country  Banks  largely  Control  Reserve  Adjust- 
ments.— The  key  to  the  problem  of  the  effect  which  the 
new  reserve  requirements  and  the  readjustment  of  reserve 
deposits  will  have  upon  the  banking  system  of  the  country 
is  found  to  a  large  degree  with  the  country  banks.  Over 
seventy-one  hundred  of  the  seventy-five  hundred  national 
banks  are  country  banks,  while  the  total  resources  of  the 
country  institutions  comprise  over  one-half  of  the  total 
resources  of  all  of  the  national  banks.  Their  strategic 
position  at  this  time  is  unequaled  by  that  of  any  other  class 
of  institution,  in  that  they  have  the  right  to  call  upon  the 
reserve  city  and  central  reserve  city  banks  for  over  $533,- 
000,000.  This  puts  them  in  a  position  where  they  can  force 
the  burden  of  adjustment,  whatever  it  may  be,  upon  the 
other  institutions.  The  country  banks  are  the  only  ones 
which  are  exclusively  creditors  in  reserve  transactions. 

Large  Reduction  in  Country  Bank  Reserves. — More- 
over, the  country  banks  wall  profit  to  a  larger  degree  than 
any  other  class  of  institution  by  the  reduction  of  their  re- 
serve requirements,  owing  to  the  fact  that  they  possess  by 
far  the  largest  amount  of  time  deposits.  According  to  the 
report  of  the  Comptroller  of  the  Currency  showing  the  con- 
dition of  the  national  banks  as  of  October  21,  1913,  the 
country  banks  were  carrying  a  16.53  per  cent  reserve,  of 
which  7.91  per  cent  consisted  of  cash  in  their  own  vaults 
and  8.62  per  cent  consisted  of  balances  available  with  re- 
serve agents.  On  that  date  the  country  banks  were  holding 
a  trifle  less  than  $56,921,542  above  the  required  legal  re- 
ser\'e,  while  their  excess  in  cash  holdings  over  and  above 
the  legal  minimum  amounted  to  over  $71,000,000.     The 

240 


RESERVES  IN  COUNTRY  BANKS  241 

country  banks  were  in  so  strong  a  position  partly  because 
of  caution  which  had  been  used  for  a  number  of  months 
in  extending  loans,  and  partly  because  of  the  fact  that  they 
have  always  been  more  liberal  in  their  reserve  holdings 
than  the  other  two  classes  of  national  banks. 

A  most  perplexing  question,  which  must  be  answered  in 
order  to  make  an  analysis  of  the  extent  to  which  a  shifting 
in  cash  will  occur,  is :  What  will  be  the  policy  of  the  country 
banks  under  the  lower  reserve  requirements?  Taking  the 
condition  at  the  last  report  as  the  basis  for  comparison,  we 
find  that  the  country  banks  will,  under  the  new  law,  be 
permitted  to  reduce  their  required  reserve  from  the  present 
minimum  of  $557,000,000  to  a  minimum  of  $362,000,000— a 
reduction  of  $195,000,000.  From  the  testimony  of  the 
bankers  before  the  Congressional  committees,  one  would 
gain  the  impression  that  it  is  unlikely  that  the  banks  will 
take  advantage  to  the  fullest  extent  of  the  new  reserve  re- 
quirement permitting  a  reduction  of  cash  in  their  own 
vaults  from  six  per  cent  to  five  per  cent.  This  remarkable 
unanimity  of  opinion  is  based  in  part  upon  the  fact  that 
at  the  present  time  banks  do  not  take  advantage  of  the  six 
per  cent  minimum  but  carry  one  or  two  per  cent  above  that 
amount.  The  excess  is  largely  the  result  of  painful  expe- 
rience in  times  of  stress  which  has  convinced  country 
bankers  that  they  must  rely  largely  on  their  own  resources, 
and  not  put  too  much  confidence  in  their  paper  resei*ve. 
The  banks  which  are  located  in  towns  and  those  which  have 
heavy  pay  rolls  can  not  as  a  rule  carry  as  low  as  a  six  per 
cent  vault  reserve.  In  many  cities  it  is  necessary  and  quite 
universal  to  find  banks  carrying  from  ten  to  twelve  per 
cent  of  cash  in  order  to  handle  these  and  similar  obligations. 
In  order  to  secure  the  necessary  amount  of  cash  for  such 
emergencies,  these  banks  must  frequently  accumulate  the 
money  from  other  institutions  several  weeks  in  advance  of 
the  time  for  its  use.  The  banks  that  have  a  surplus  of  cash 
sell  it  to  an  institution  which  has  a  use  for  it,  rather  than 
send  it  to  a  reserve  agent  in  another  city.  They  thereby 
16 


242       OPERATION  OF  THE  NEW  BANK  ACT 

save  express  charges.  The  banks  which  purchase  the  cash 
will  probably  give  to  the  seller  a  New  York  draft  in  pay- 
ment. Although  it  is  not  safe  to  presume  that  the  view  of 
the  bankers  while  the  bill  was  in  the  progress  of  formation 
will  represent  the  mature  judgment  of  the  banking  frater- 
nity, and  that  therefore  a  considerable  reduction  may  occur 
in  the  cash  reserve,  yet  the  fact  remains  that  the  banks  will 
not  at  once  acquire  implicit  confidence  in  the  Federal  re- 
serve banks.  They  will  not  rely  largely  upon  the  reserve 
banks  until  these  institutions  have  demonstrated  their 
ability  to  take  care  of  their  customers  under  all  conditions. 
This  may  require  many  years.  If  foreign  experience  is  any 
criterion,  the  tendency  should  be  toward  a  small  vault  re- 
serve with  the  main  reliance  upon  the  reserve  carried  with 
the  Federal  reserve  banks. 

Elimination  of  Redemption  Fund  from  Reserves. — 
Considerable  objection  has  been  raised  by  the  bankers  to 
the  elimination  of  the  five  per  cent  redemption  fund  as  a 
part  of  the  bank's  reserve.  The  Federal  Reserve  Act  pro- 
vides that  on  and  after  its  passage  banks  shall  no  longer 
be  permitted,  in  calculating  their  reserves,  to  include  the 
five  per  cent  redemption  fund  as  has  heretofore  been  the 
ease.  This  will  eliminate,  according  to  the  latest  informa- 
tion, something  less  than  $24,000,000  of  cash  from  the 
amount  which  the  country  banks  can  count  as  a  part  of 
their  cash  reserve.  However,  in  spite  of  the  fact  that  the 
country  banks  as  a  class  have  been  especially  progressive 
as  regards  the  issue  of  national  bank  notes,  the  elimination 
of  the  five  per  cent  fund  will  rest  less  heavily  upon  them 
than  upon  the  other  classes  of  institutions,  for  the  reason 
that  the  country  banks  have  habitually  kept  a  surplus  cash 
reserve.  The  five  per  cent  redemption  fund  amounts  to  a 
little  less  than  two-thirds  of  one  per  cent  upon  the  deposits 
subject  to  reserve  requirements,  and  its  elimination  as  a 
practical  matter  about  offsets  the  reduction  in  the  cash  re- 
serve from  six  to  five  per  cent. 


RESERVES  IN  COUNTRY  BANKS  243 

New  Reserve  Requirements  for  Country  Banks, — 
In  the  preceding  chapter  the  effort  made  by  the  country 
bankers  to  have  a  provision  inserted  in  the  bill  allowing 
them  to  keep  one-third  of  their  required  reserve  on  deposit 
with  their  reserve  agents  was  reviewed.  The  law,  as  it  was 
enacted,  did  not  grant  this  privilege  and  provides  the  fol- 
lowing reserve  requirement  for  the  country  banks: 

"When  the  Secretary  of  the  Treasury  shall  have  offi- 
cially announced,  in  such  manner  as  he  may  elect,  the  estab- 
lishment of  a  Federal  reserve  bank  in  any  district,  every 
subscribing  member  bank  shall  establish  and  maintain  re- 
serves as  follows:  (a)  A  bank  not  in  a  reserve  or  central 
reserve  city  as  now  or  hereafter  defined  shall  hold  and 
maintain  reserves  equal  to  twelve  per  centum  of  the  aggre- 
gate amount  of  its  demand  deposits  and  five  per  centum  of 
its  time  deposits,  as  follows : 

' '  In  its  vaults  for  a  period  of  thirty-six  months  after  said 
date  five-twelfths  thereof  and  permanently  thereafter  four- 
twelfths. 

''In  the  Federal  reserve  bank  of  its  district,  for  a  period 
of  twelve  months  after  said  date,  two-twelfths,  and  for 
each  succeeding  six  months  an  additional  one-twelfth,  until 
five-twelfths  have  been  so  deposited,  which  shall  be  the 
amount  permanently  required. 

"For  a  period  of  thirty-six  months  after  said  date  the 
balance  of  the  reserves  may  be  held  in  its  own  vaults,  or 
in  the  Federal  reserv'e  bank,  or  in  national  banks  in  reserve 
or  central  reserve  cities  as  now  defined  by  law. 

"After  said  thirty-six  months'  period  said  reserves, 
other  than  those  hereinbefore  required  to  be  held  in  the 
vaults  of  the  member  banks  and  in  the  Federal  reserve 
bank,  shall  be  held  in  the  vaults  of  the  member  bank  or  in 
the  Federal  reserve  bank,  or  in  both,  at  the  option  of  the 
member  bank." 

Perhaps  the  following  table  may  help  to  visualize  the 
steps  which  will  be  taken  and  the  final  result  which  vnW  be 
accomplished  in  the  adjustment  of  the  countrj'  bank  re- 
serves : 


244       OPERATION  OF  THE  NEW  BANK  ACT 

REQUIREMENTS    OF    BANKS 

Country  banks  should  hold  reserves : 

1.  Of  twelve  per  cent  on  demand  deposits. 

2.  Of  five  per  cent  on  time  deposits. 

3.  This  reserve  to  be  segregated  as  follows: 


12 

18 

24 

30 

36 

moB. 

mos. 

mos. 

mos. 

mos. 

5/12 

5/12 

5/12 

5/12 

5/12 

2/12 

3/12 

4/12 

5/12 

5/12 

B 

B 

B 

B 

B 

There- 
after. 


In  vaults  (compulsory) 

In  Federal  reserve  bank  (com- 
pulsory)  

For  balance  see  appropriate  foot- 
note   


4/12 

5/12 

C 


B .  The  remainder  to  be  held  for  the  first  thirty-six  months  either  in  their  vaults, 
in  reserve  banks  or  in  national  banks  in  reserve  cities  or  central  reserve  cities. 

C.  Thereafter  may  be  held  in  vaults  or  in  reserve  banks. 

Country  Banks  can  shift  the  Entire  Burden. — It  is 

possible  for  a  country  banker,  if  he  should  so  desire,  to 
shift  his  entire  cash  reserve  at  once  from  his  present  reserve 
agent  to  the  Federal  reserve  bank.  This  is  very  unlikely  to 
occur.  In  the  first  place  the  Federal  reserve  bank  will 
probably  make  no  attempt  to  encourage  such  a  radical  shift 
and  doubtless  will  discourage  it.  The  country  banker,  more- 
over, will  find  it  will  take  some  time  for  the  Federal  reserve 
banks  to  build  up  their  collection  machinery,  and  during 
the  intei'val  it  will  be  necessary  for  him  to  depend  upon  his 
reserve  agents  for  this  work.  Some  of  the  bankers  are  of 
the  opinion  that  the  new  reserve  requirements  will  put  a 
positive  burden  upon  them,  because  they  feel  they  can  not 
reduce  their  present  accounts  with  reserve  agents  without 
disorganizing  their  exchange  and  collection  business.  If 
this  view  is  correct,  the  money  to  make  pajTnents  to  the 
Federal  reserve  banks  must  be  secured  from  other  sources. 
This  is  a  very  extreme  view,  and  will  probably  not  accord 
with  the  facts  provided  the  Federal  reserve  banks  collec- 
tion operations  are  vigorously  developed. 

However,  it  is  practically  certain  that  for  some  time  the 
country  banks  will  be  forced  to  carry  considerable  balances 


RESERVES  IN  COUNTRY  BANKS  245 

with  their  present  reserve  agents,  if  they  are  to  handle  sat- 
isfactorily the  business  of  their  customers.  This  course  of 
action  is  prompted  by  other  important  reasons.  The  country 
banker  is,  as  a  rule,  a  cautious  man.  He  will  not  withdraw 
his  New  York  and  Chicago  balances  until  he  sees  that  the 
new  law  is  going  to  work  satisfactorily ;  for  to  do  so  would 
cut  him  off  from  all  the  assistance  which  he  ordinarily  re- 
ceives from  his  reserve  agent,  the  loss  of  which  he  will  not 
voluntarily  suffer. 

Objections  to  Changing  Reserve  Arrangements. — 
The  reserve  agents  are,  as  a  class,  reasonably  liberal  in  their 
treatment  of  their  correspondents.  A  country  banker  hav- 
ing a  good  balance  and  finding  a  sudden  and  unexpected 
demand  for  cash,  can  call  the  reserve  agent  on  the  long  dis- 
tance telephone  and  have  the  required  amount  of  money 
forwarded  on  the  next  train.  A  banker  in  Johnstown,  Pa., 
for  example,  can  call  his  reserve  agent  in  Pittsburgh  at 
10  A.M.,  and  have  the  cash  in  his  possession  Avithin  two  or 
three  hours.  Or  he  can  call  up  Philadelphia  and  by 
the  following  morning  have  secured  a  part  of  his  balance 
with  his  reserve  agent.  In  other  words,  the  reserve 
agents  will  ship  money,  if  the  amount  demanded  is  on  de- 
posit, simply  upon  a  telephone  call,  relying  upon  a  eon- 
firming  order  to  follow  by  mail.  It  must  be  borne  in  mind 
now  that  we  are  outlining  the  service  rendered  by  the  re- 
serve agent  in  normal  times  when  reserve  accounts  are 
really  licpiid  and  at  the  service  of  the  country  banks. 

Some  country  bankers  fear  that  the  Federal  reserve 
banks  will  not  be  as  liberal  and  expeditious  in  their  hand- 
ling of  such  business.  They  contend  that  the  promptness 
of  reserve  agents  is  the  result  of  competition  and  the  real- 
ization that  if  these  hurry  orders  are  not  heeded  the  country 
bank  will  transfer  its  balance  to  some  other  institution. 
The  Federal  reserve  bank,  on  the  other  hand,  will  have  no 
such  spur  to  prompt  action.  The  Federal  reserve  bank  may 
take  the  stand  that  it  will  not  ship  money  until  it  has  a 
written  order  authorizing  its  transfer.  Such  a  course  will 
require  a  country  bank  to  keep  a  larger  reserve  in  its  own 


246       OPERATION  OF  THE  NEW  BANK  ACT 

vaults,  and  will  to  that  amoimt  decrease  the  extent  of 
mobilization,  which  is  one  of  the  objects  sought  by  the  Act. 
These  objections  are  predicated,  of  course,  upon  the  assump- 
tion that  the  bankers  who  form  a  majority  of  the  board  of 
directors  of  the  Federal  reserve  bank  will  take  an  unsym- 
pathetic attitude  toward  their  constituents  and  wdll  cease 
to  be  progressive  business  men.  Moreover,  the  objection 
is  to  a  considerable  degree  weakened  when  we  remember 
that  each  Federal  reserve  bank  is  required  and  authorized 
to  establish  branches  at  various  points  in  its  district,  to 
which  member  banks  may  go  when  they  need  money.  The 
existence  of  these  branches  should  reduce,  to  a  considerable 
extent,  the  period  of  time  required  to  secure  a  supply  of 
cash. 

Competition  no  longer  May  Assure  Liberal  Loans  to 
Country  Banks. — In  line  with  this  objection  is  another 
raised  by  the  country  banker  to  the  requirements  of  the  law 
which  will  compel  him  to  borrow  chiefly  from  the  Federal 
reserve  bank.  We  have  seen  that  a  large  proportion  of  the 
country  banks  are  borrowers,  especially  during  the  crop 
moving  seasons.  In  arranging  their  loans  they  take  advan- 
tage of  the  active  competition  existing  between  the  various 
reserve  city  and  central  reserve  city  banks,  and  are  assured 
of  as  liberal  treatment  as  good  business  will  warrant,  be- 
cause of  the  rivalry  between  these  institutions  for  accounts. 
Should  the  entire  deposit  balances  be  transferred- from  the 
existing  reserve  agents  to  the  Federal  reserve  banks,  the 
reserve  city  and  central  reserve  city  banks  will  not  feel 
under  any  obligations  to  loan  money  to  the  country  banks 
after  the  balances  are  withdrawn;  and  the  withdrawal  of 
these  balances  will,  to  a  large  degree,  remove  the  ability  of 
the  resen^e  agents  to  make  such  loans.  When  the  country 
bank  goes  to  a  Federal  reserve  bank  and  applies  for  assist- 
ance, it  is  alleged  that  it  will  be  at  the  mercy  of  one  man's 
judgment  and  favor;  that  his  estimate  of  the  skill  with 
which  the  bank  is  managed,  of  the  value  of  the  paper  which 
it  has  discounted  and  of  the  wisdom  of  granting  it  liberal 


RESERVES  IN  COUNTRY  BANKS  247 

loans,  will,  to  a  large  degree,  be  final.  In  place  of  competi- 
tion assuring  fair  treatment,  the  bank  must  rely  upon  its 
ability  to  keep  in  the  favor  of  the  Federal  reserve  agent, 
who  will  really  run  the  bank.  On  the  other  hand,  it  is 
argued  that  the  country  banker  may  appeal  to  the  board  of 
directors  of  the  Federal  reserve  bank  to  secure  fair  treat- 
ment, and  that  if  he  fails  to  get  it  there,  he  may  appeal  to 
the  Federal  Reserve  Board.  This  is  in  part  open  to  re- 
buttal. 

As  a  matter  of  fact  it  is  likely  that  cases  of  such  alleged 
ill  treatment  will  crop  up  from  time  to  time ;  but  if  the 
Federal  reserve  agents  are  of  a  high  type  and  if  their  work 
is  supervised  by  a  competent  finance  committee,  and,  finally, 
if  the  boards  of  directors  of  the  reserve  banks  take  an  active 
interest  in  their  institutions,  it  is  not  likely  that  any  fla- 
grant favoritism  or  arbitrary  misuse  of  power  will  be  fre- 
quently encountered.  Again  we  are  impressed  with  the 
fact  that  the  success  of  the  system  in  this  respect,  as  in  most 
others,  depends  upon  personal  supervision.  If  the  right 
type  of  men  be  selected  to  manage  the  Federal  reserve 
banks,  there  will  be  little  cause  for  complaint  from  the  con- 
stituent banks. 

Another  argument  in  support  of  the  contention  that  no 
bank  should  be  entirely  divorced  from  its  reserve  agents,  is 
that  if  they  were  allowed  to  keep  a  part  of  its  reserve,  as  here- 
tofore, the  operations  of  borrowing  and  rediscouuting  would 
be  greatly  facilitated.  The  country  bank  could  negotiate 
loans  from  its  former  reserve  agent,  turning  over  to  it 
commercial  paper  or  other  collateral  as  security;  and  this 
reserve  agent,  whose  quarters  would  in  all  probability  be 
within  a  few  squares  of  the  Federal  reserve  bank  or  one 
of  its  branches,  could  personally  attend  to  the  necessan' 
rediscounting,  in  order  to  reimburse  itself  for  the  funds 
which  it  had  advanced  to  the  country  banks.  Thus,  instead 
of  relying  upon  long  distance  correspondence  to  secure  the 
desired  rediscounts  or  of  taking  the  time  of  an  official  of 
the  country  bank  to  journey  to  the  city  in  which  the  Fed- 


248      OPERATION  OF  THE  NEW  BANK  ACT 

eral  reserve  bank  or  the  nearest  branch  is  located,  the  entire 
time  and  attention  of  the  officials  of  the  country  bank  would 
be  devoted  to  the  management  of  their  institutions.  This 
is  advantageous  when  the  need  for  cash  arises,  for  such 
occasions  are  usually  the  ones  in  which  the  banker's  presence 
is  vital.  As  a  matter  of  fact  a  method  has  been  created 
which  will  overcome  this  objection.  It  is  provided  in  Sec- 
tion 20  that  "No  member  bank  shall  act  as  the  medium 
or  agent  of  a  non-member  bank  in  applying  for  or  receiv- 
ing discounts  from  a  Federal  reserve  bank  under  the  pro- 
visions of  this  Act,  except  by  permission  of  the  Federal  Re- 
serve Board."  This  provision  inferentially  gives  to  the 
Federal  Reserve  Board  the  power,  when  advisable,  to  au- 
thorize country  banks  to  rediscount  through  reserve  city  or 
central  reserve  city  institutions,  under  suitable  regulations. 
Degree  of  Rigidity  of  New  Reserve  Requirements. — 
One  of  the  most  important  objections  which  can  be  raised 
to  the  reserve  requirements  provided  for  the  country  banks 
is  the  fact  that  the  manner  in  which  the  reserves  shall  be 
kept  is  very  rigid.  After  the  transition  stage  has  been 
passed,  or  subsequent  to  three  years  from  the  date  of  the 
establishment  of  the  Federal  reserve  bank,  the  country  bank 
will  be  required  to  keep  four-twelfths  of  its  minimum  re- 
serve in  its  own  vaults,  five-tw^elfths  on  deposit  with  the  Fed- 
eral reserve  bank  and  the  remaining  three-twelfths  either  in 
its  own  vaults  or  with  the  Federal  reserve  bank,  or  both, 
as  it  may  elect.  As  a  matter  of  fact,  only  one-quarter  of 
the  cash  reserve  of  a  bank  can  be  handled  according  to  the 
discretion  of  the  directors.  It  is  probable  that  a  bank  will 
keep  a  larger  reserve  than  the  legal  minimum.  However, 
this  will  not  insure  it  against  a  violation  of  reserve  require- 
ments, thereby  subjecting  itself  to  a  tax  or  such  other  penalty 
as  may  be  prescribed.  A  run  may  reduce  the  cash  re- 
serve which  it  has  in  its  vaults  below  the  specified  four- 
twelfths  ;  and  w^hile  the  surplus  over  and  above  the  remain- 
ing nine-twelfths  in  the  vaults  of  the  Federal  reserve  bank 
may  be  large  enough  to  offset  the  loss,  and  the  aggregate 


RESERVES  IN  COUNTRY  BANKS  249 

cash  holdings  in  the  bank's  vaults  and  on  deposit  with  the 
Federal  reserve  bank  may  exceed  the  minimmn  required 
reserve,  nevertheless,  according  to  the  wording  of  the  law, 
the  bank  will  still  be  technically  in  default,  because  the 
cash  in  its  own  vaults  does  not  equal  four-twelfths  of  the 
minimum  reserve  which  it  is  required  to  keep.  The  pen- 
alty, however,  would  doubtless  be  imposed  only  in  extreme 
cases  where  the  member  bank  refused  or  neglected  to  re- 
plenish its  vault  reserve  by  drawing  upon  the  reserve  bank 
against  its  balance  therein.  This  operation  is  clearly  cov- 
ered in  the  following  provision  included  in  Section  19 : 

"The  reserve  carried  by  a  member  bank  with  a  Federal 
reserve  bank  may,  under  the  regulations  and  subject  to  such 
penalties  as  may  be  prescribed  by  the  Federal  Reserve 
Board,  be  checked  against  and  withdrawn  by  such  member 
bank  for  the  purpose  of  meeting  existing  liabilities:  Pro- 
vided, however,  That  no  bank  shall  at  any  time  make  new 
loans  or  shall  pay  any  dividends  unless  and  until  the  total 
reserve  required  by  law  is  fully  restored." 

Probable  Shifting  of  Reserve  Balances. — It  is  impos- 
sible to  tell  with  mathematical  accuracy  what  will  be  the 
extent  to  which  funds  will  be  shifted  from  the  present  re- 
serve centers  to  the  Federal  reserve  banks  in  each  district. 
In  many  ways  this  is  the  most  serious  problem  which  is 
involved  in  the  establishment  of  the  Federal  Reserve  sys- 
tem. Even  though  the  system  should  work  perfectly  after 
it  has  been  established,  there  will  be  ample  ground  for 
strong  opposition,  if  it  should  appear  that  during  the 
establishment  of  the  system  there  is  a  serious  dislocation 
of  bank  credits.  The  funds  which  are  now  on  deposit  with 
the  reserve  city  and  central  reserve  city  banks  represent  an 
accumulation  of  fifty  years,  for  which  definite  channels  of 
employment  have  been  developed.  Upon  this  money  de- 
pends to  a  large  degree  the  business  of  our  large  cities. 
Apparently  an  important  reorganization  must  occur.  The 
money,  which  under  the  law  must  be  paid  to  the  Federal 
reserve  banks,  representing  capital  stock  subscriptions  and 


250       OPERATION  OF  THE  NEW  BANK  ACT 

the  payment  of  the  reserve  which  the  member  banks  are 
required  to  keep  with  them  as  capital,  must  be  withdrawn 
from  its  present  employment.  The  enforced  idleness  of 
funds  during  the  period  of  these  withdrawals  should  be  cut 
to  the  minimum  and  the  shifting  should  be  as  gradual  and 
as  nearly  automatic  as  possible.  Even  under  the  most 
favorable  conditions,  adroit  and  exceedingly  skillful  man- 
agement by  the  Federal  Reserve  Board  and  by  the  various 
Federal  reserve  banks  will  be  necessary.  This  will  be  even 
more  true  of  the  member  banks,  if  this  change  is  to  be 
accomplished  without  embarrassing  business.  Unless  there 
is  some  inherent  defect  in  the  plan  which  makes  it  unwork- 
able, however,  there  is  no  reason  to  expect  that  the  change 
can  not  be  successfully  managed. 

As  a  banking  problem  it  pales  into  significance  when 
compared  with  the  exploit  of  the  French  people  in  paying 
the  German  war  indemnity  amounting  to  $1,000,000,000,  a 
feat  that  was  accomplished  without  in  the  least  interfering 
with  commercial  business  in  France.  The  success  of  the 
French  is  to  be  attributed  almost  entirely  to  the  perfect 
cooperation  of  all  classes  with  the  Bank  of  France,  which 
successfully  concluded  this  financial  operation  without  a 
hitch  or  disturbance. 

Readjustment  Dependent  upon  Perfect  Coopera- 
tion.— Too  much  emphasis  can  not  be  placed  upon  the  fact 
that  the  success  of  the  reorganization  of  our  banking  system 
depends  upon  the  complete  cooperation  of  our  existing 
banks.  It  is  possible  for  them,  by  pursuing  a  short-sighted 
policy,  to  bring  disaster,  and  it  is  the  duty  of  the  leading 
bankers,  of  the  board  of  directors  of  each  Federal  reser^-e 
bank,  as  well  as  of  the  Federal  Reserve  Board  by  precept 
and  example,  to  secure  unselfish  cooperation  on  the  part 
of  all. 

No  question  connected  with  the  Federal  Reserve  Act  is 
more  anxiously  inquired  about  than  the  extent  to  which 
funds  must  be  transferred  in  the  establishment  of  the  sys- 
tem.   Obviously  the  point  of  departure  in  the  study  of  this 


RESERVES  IN  COUNTRY  BANKS 


251 


problem  is  the  country  banks.  As  we  have  seen,  they  are 
the  creditor  banks,  and  it  is  in  their  power  to  draw  part  or 
all  of  their  contributions  from  the  others.  It  is  very  diffi- 
cult for  us  to  make  any  estimate  which  will  show  accurately 
how  great  will  be  the  withdrawals,  or  the  necessity  for  them, 
on  the  part  of  the  country  banks.  The  following  computa- 
tions are  presented,  not  with  the  idea  that  they  reflect  ex- 
actly what  will  occur,  but  simply  to  suggest  how  the  reor- 
ganization of  reserves  will  work,  and  as  a  general  indication 
of  the  way  in  which  the  working  out  of  the  problem  will 
depend  upon  the  course  of  action  chosen  by  the  banks.  The 
computations  are  intended  not  as  prophecies,  but  a.s  the 
means  of  discovering,  if  possible,  the  course  of  action  which 
will  accomplish  the  required  end  with  the  smallest  possible 
disturbance  to  banking  and  to  business  conditions  consistent 
with  banking  practice. 

With  these  qualifications  continually  in  mind  the  reader 
is  invited  to  review  the  following  computations  showing  the 
required  readjustment  of  cash  reserves  of  the  country 
banks  during  the  first  twelve  months,  and  again  from  the 
twenty-fifth  to  the  thirtieth  month.  This  second  period 
represents  the  point  of  greatest  strain  upon  our  banking 
system,  because  the  reserve  payments  by  the  country  banks, 
the  reserve  city  and  central  reserve  city  banks  reach  their 
maximum  in  that  period. 

COUNTRY  BANKS  (7136,  omitting  Hawaii  and  Alaska) 

Reserve  Requirements:    12  Per  Cent  of  Demand  Deposits  and  5  Per  Cent 
OF  Time  Deposits 


In  vaults  (compulsory) 

In  Federal  reserve  bank  (compul- 
sory)    


12 
mos. 

18 
mos. 

24 
mos. 

30 
mos. 

36 
mos. 

5/12 
2/12 

6/12 
3/12 

6/12 

4/12 

5/12 
5/12 

5/12 
6/12 

There- 
after. 


4/12 
5/12 


The  remainder  must  be  held  for  the  first  36  months  either  in  the  vaults  of  the 
bank,  in  the  Federal  reserve  banks,  or  in  central  or  city  reserve  banks. 

Thereafter  it  must  be  held  in  the  vaults  of  Federal  reserve  banks  or  in  the 
vaults  of  the  member  banks. 


252       OPERATION  OF  THE  NEW  BANK  ACT 


Net  deposits  subject  to  reserve  (Oct.  21, 1913) 
Time  deposits 


Demand  deposits. 


12  per  cent  reserve  on  demand  deposits. 
5  per  cent  reserve  on  time  deposits 


Total  minimum  reserve  requirement.  .  . 

Of  above  the  bank  must  hold  as  a  minimum 
in  own  vaults 

And  on  deposit  with  Federal  bank 

The  balance,  on  presumption  of  the  smallest 
possible  shifting  of  cash,  would  remain 
with  reserve  agents 


Present  cash  holdings. ....... 

New  minimum  cash  holdings. 


Excess  available  for  Federal  bank. 


Payments  by  country  banks  to  Federal  bank 

Reserve  with  Federal  bank 

Subscription  to  stock 

United  States  deposits 


Total  payment  to  Federal  bank 

Excess  in  cash  in  vaults  available  for 
Federal  banks 


Deficit. 


During  the 
first  year. 


$3.712,953,422.3.3 
1,204,156,172.74 


From  the  25th 
to  30th  month. 


$2,508,797,249.59 


$301,055,669.95 
60,207,808.64 


$361,263,478.59 


$150,526,449.33 
60.210.579.73 


150.526,449.33 


$361,263,478.39 


$269,469,648.45 
150,526,449.33 


$118,943,199.12 


$60,210,579.73 
29,638.448.76 
36,966,693.01 


$3,712,953,422.33 
1,204.156.172.74 


$2,508,797,249.59 


$301,055,669.95 
60.207,808.64 


$361,263,478.59 


$150,526,449.33 
150,526,449.33 


60,210,579.73 


$361,263,478.39 


$269,469,648.45 
150,526,449.33 


$118,943,199.12 


$126,815,721.50 
118,943,199.12 


$150,526,449.33 
29,638,448.76 
36,966,693.01 


$217,131,591.10 
118,943,199.12 


$7,872,522.38  I        $98,188,391.98 


It  would  be  possible  to  make  a  calculation  in  the  same 
way,  covering  each  of  the  six  periods  representing  the  vari- 
ous stages  in  the  readjustment  of  reserves  as  set  forth  in  the 
law.  This,  however,  would  simply  be  a  repetition  of  the 
same  method  and  may  be  easily  worked  out  by  any  one  who 
desires  to  examine  the  shifting  in  greater  detail.  Such  a 
calculation  would  show  the  gradations  by  which  the  change 
would  be  accomplished,  from  the  situation  during  the  first 
twelve  months,  to  the  point  of  maximum  strain  from  the 
twenty-fifth  to  the  thirtieth  month.  In  a  later  chapter  the 
final  strain  upon  the  banking  system,  incident  to  the  read- 
justment of  reserves  at  the  end  of  thirty-six  months,  is  con- 
sidered. At  that  time  a  proportion  of  the  member  banks' 
reserves   can   no   longer  be   carried   with   present   reserve 


RESERVES  IN  COUNTRY  BANKS  253 

agents,  but  must  be  shifted  to  the  banks'  vaults  or  to  the 
reserve  banks.  This  phase  of  the  reserve  problem  is  not 
considered  at  all  in  the  present  computations.  It  is  inter- 
esting to  notice  the  difference  in  the  new  method  of  calcu- 
lating the  reserve  over  that  which  has  heretofore  prevailed. 
The  calculation  of  the  required  reserve  of  a  bank  is  an 
intricate  matter,  and  is  fully  covered  by  the  instructions 
issued  by  the  Comptroller  of  the  Currency.  The  only  im- 
portant change  which  the  Federal  Reserv^e  Act  makes  in 
this  calculation  is  (1)  to  omit  the  five  per  cent  redemption 
fund  as  a  part  of  the  bank's  reserve,  and  (2)  to  require  the 
separate  totaling  of  demand  deposits,  and  of  time  deposits 
payable  upon  notice  of  at  least  thirty  days. 

Method  of  Calculating  the  New  Reserves. — The  above 
calculation  really  begins  with  the  item  "net  deposits," 
which  is  the  same  thing  in  both  cases,  the  presumption  be- 
ing that  the  calculation,  as  at  the  beginning  of  the  twenty- 
fifth  month  from  the  establishment  of  the  system,  is  based 
upon  the  figures  of  to-day.  By  "net  deposits"  is  meant 
the  gross  or  actual  deposits  of  the  bank  less  certain  items 
against  which  the  bank  does  not  have  to  keep  a  reserve. 
The  calculation  to  determine  net  deposits  is  an  intricate 
one,  and  need  not  be  reproduced  in  this  connection.  One 
of  the  most  important  items  which  is  deducted  from  the 
gross  deposits,  by  way  of  illustration,  is  United  States  de- 
posits, against  which,  under  the  Vreeland-Aldrich  Act,  no 
reserve  need  be  kept.  After  the  net  deposits  have  been  as- 
certained, it  will  be  necessary,  from  this  time  on,  for  the 
bank  to  separate  them  into  two  classes,  (1)  demand  de- 
posits, and  (2)  time  deposits.  "When  this  has  been  done,  the 
next  step  will  be  to  calculate  the  required  reserve  against 
each ;  that  is  to  say,  the  twelve  per  cent  reserve  required  on 
demand  deposits  and  the  five  per  cent  reserve  required  on 
time  deposits.  The  sum  of  these  two  reserves  represents  the 
total  minimum  reseiwe  requirement.  No  distinction  is  made 
between  the  component  parts  of  this  total  minimum  reserve 
in  determining  what  proportion  of  it  shall  be   (a)   in  the 


254       OPERATION  OF  THE  NEW  BANK  ACT 

banks'  vaults,  (b)  on  deposit  with  its  Federal  reserve  bank, 
or  (e)  on  deposit  with  present  reserve  agents. 

During  the  first  twelve  months,  five-twelfths  of  the  total 
minimum  reserve  must  be  kept  in  the  vaults  of  the  country 
banks;  at  least  two-twelfths  must  be  kept  on  deposit  with 
the  Federal  resein^e  bank ;  while  the  remaining  five-twelfths 
may  be  kept  either  in  the  vaults  of  the  country  banks,  on 
deposit  with  the  Federal  reserve  banks  or  on  deposit  with 
the  present  reserve  agents  in  whole  or  in  part,  as  the  country 
banks  may  elect.  It  has  been  assumed  that  the  country 
banks  will  keep  as  much  of  this  optional  portion  as  possible 
on  deposit  with  their  present  reserve  agents,  both  because 
these  balances  will  to  a  considerable  degree  be  necessary 
in  the  formative  stage  of  the  new  system  to  facilitate  the 
selhng  of  exchange  and  collections,  and  because  the  country 
banks  will  no  doubt  very  properly  extend  every  considera- 
tion to  their  present  reserve  agents  in  assisting  their  adjust- 
ment to  the  new  conditions.  If  the  country  banks  should 
take  a  totally  unsympathetic  attitude  toward  the  reserve 
city  and  central  reserve  city  banks,  and  if  the  reserve  city 
banks  should  assume  the  same  position  toward  the  central 
reserve  city  banks,  it  can  be  stated  that  the  system  is 
doomed  to  failure.  However,  there  is  no  business  motive 
or  reason  to  suppose  that  the  country  banks  and  the  reserve 
city  banks  will  adopt  any  short-sighted  policy. 

Payments  Required  of  Country  Banks  within  the 
First  Three  Years. — Upon  the  inauguration  of  the  new 
system,  the  country  banks  will  be  required  to  deposit  with 
the  Federal  reserve  banks  $60,210,579.73,  representing  two- 
twelfths  of  their  required  reserve  on  their  deposits,  as 
stated  in  the  latest  report  of  the  Comptroller  of  the  Cur- 
rency as  of  October  21,  1913.  These  payments  will  grad- 
ually increase  with  each  succeeding  period  of  readjustment 
until  at  the  end  of  the  twenty-fifth  month  they  will  have 
reached  their  maximum,  the  total  payments  up  to  that  time 
aggregating,  upon  the  basis  of  the  deposits  of  the  country 
banks  at  the  present  time,  $150,526,449.33.  Along  with 
this  gradual  and  steady  increase  of  the  deposits  with  the 


RESERVES  IN  COUNTRY  BANKS  255 

Federal  reserve  banks  there  will  be  a  corresponding  de- 
crease in  the  optional  balances  carried  in  their  own 
vaults,  with  the  Federal  reserve  banks,  or  on  deposit  with 
the  present  reserve  agents.  The  latter  item  will  entirely 
disappear  from  the  reserve  calculation  at  the  end  of  the 
thirty-six-month  period.  It  will  be  noticed  that  the  total 
reserve  does  not  increase,  and,  as  a  matter  of  fact,  is  the 
same  at  the  beginning  as  it  is  at  the  end. 

Another  interesting  point  brought  out  by  the  above  cal- 
culations is  that  the  minimum  amount  of  cash  which  the 
banks  can  keep  is  very  much  less  than  the  amount  which, 
they  now  hold  and  that  the  amount  of  cash  which  the  coun- 
try banks  must  hold  docs  not  increase  as  the  period  pro- 
gresses, but  remains  stationary  until  the  end  of  the  thirty- 
sixth  month,  at  which  time  a  reduction  from  five-twelfths 
to  four-twelfths  of  the  total  reserve  is  permitted.  Thus  it 
follows  that  from  the  inauguration  of  the  sj'stem  until  the 
end  of  the  thirty-sixth  month  the  country  banks  will  have 
over  $118,000,000  cash  on  hand  that  will  be  available  to 
make  payments  and  finance  the  reorganization  of  the  bank- 
ing system.  The  total  pajTnents  which  the  country  banks 
must  make  to  the  Federal  reserve  banks  aggregate,  during 
the  first  twelve  months,  $126,815,721.50,  while  at  the  be- 
ginning of  the  twenty-fifth  month  the  payments  will  have 
aggregated  $217,131,591.10.  The  preceding  calculations 
are  based  upon  the  presumption  that  the  country  banks  will 
use  all  of  their  available  cash  over  and  above  the  required 
minimum  reserve  in  making  the  payment  to  the  Federal 
reserve  banks.  In  other  w^ords,  they  will  call  upon  their 
reserve  agents  for  as  little  money  as  possible,  keeping  their 
present  deposit  balances  intact  so  far  as  they  can  do  so. 

How  the  Secretary  of  the  Treasury  Can  Assist  the 
Readjustment. — Upon  the  additional  assumption  that  the 
Socrotary  of  the  Treasury  will  transfer  from  the  present 
niitional  bnnk  depositaries  to  the  reserve  banks  the  entire 
United  States  deposits,  we  find  that  during  the  first  year 
the  country  banks  would  have  to  withdraw  only  $7,872,- 
522.38  from  their  reserve  agents.     It  is  evident  that  these 


!^5()       OPERATION  OF  THE  NEW  BANK  ACT 

withdrawals  would  be  followed  by  others  as  the  succeeding 
steps  in  the  reorganization  plan  are  taken,  so  that  by  the 
time  the  first  very  severe  strain  is  encountered,  at  the  be- 
ginning of  the  twenty-fifth  month,  the  country  banks  would 
have  been  compelled  to  withdraw  a  total  of  $98,188,391.98. 
The  objection  will  at  once  be  raised  that  this  assumption  is 
not  likely  to  be  realized.  However,  the  purpose  of  making 
it  is  to  show  the  minimum  extent  of  the  load  which  the 
reserve  agents  must  bear  in  financing  the  requirements  of 
the  country  banks.  It  will  also  be  argued  with  much  force 
that  the  withdrawal  of  the  entire  United  States  deposits 
is  unlikely.  If  the  Secretary  of  the  Treasury  should  con- 
clude to  leave  even  one-quarter  of  the  present  United  States 
deposits  with  the  country  banks,  it  would  not  be  necessary, 
upon  the  basis  of  the  above  assumption,  to  call  for  any  of 
their  deposits  with  their  reserve  agents  during  the  first 
year. 

The  Secretary  of  the  Treasury  has  absolute  discretion, 
under  the  terms  of  the  Federal  Reserve  Act,  in  handling 
the  government's  balances.  He  may  keep  them  in  whole 
or  in  part  on  deposit  with  member  banks  of  the  Federal 
reserve  system;  he  may  deposit  them  in  whole  or  in  part 
with  the  Federal  reserve  banks ;  or  he  may  keep  any  or  all 
of  them  in  the  Treasury.  As  a  matter  of  fact,  he  has  an- 
nounced that  he  will  use  the  great  power  of  his  office  to  the 
limit  in  aiding  the  banks  to  adjust  themselves  to  the  new 
system,  and  in  view  of  the  fact  that  he  has  $150,000,000  or 
$200,000,000  in  the  Treasury  which  he  can  deposit  in  the 
Federal  reserve  banks,  it  might  well  be  assumed,  in  the 
above  calculation,  that  the  United  States  deposits  could  be 
ignored,  on  the  ground  that  they  would  remain  with  the 
country  banks.  However,  the  government  deposits  are  an 
element  in  the  problem.  To  be  on  the  safe  side  we  have 
presumed  throughout  the  following  computation  that  the 
Secretary  of  the  Treasury  will  withdraw  them,  not  because 
it  is  certain  that  he  will  take  this  step,  but  because  it  is  in- 
tended to  show,  even  with  adverse  action  on  his  part,  the 
extent  of  the  strain  upon  the  member  banks. 


RESERVES  IN  COUNTRY  BANKS  257 

Options  open  to  Country  Banks  in  Shifting  Re- 
serves,— 111  view  of  the  gloomy  propheeies  that  have  been 
made  concerning  the  enormous  amount  of  money  which  will 
be  withdrawn  by  the  country  banks,  the  results  of  the  above 
calculations  are  rather  startling.  The  explanation  of  the 
small  reduction  of  the  reserve  balances  which  will  be  neces- 
sary is  to  be  found  in  the  revision  made  in  the  reserve  re- 
quirement by  the  Senate,  by  which  the  banks  are  authorized 
to  keep  a  five  per  cent  reserv^e  instead  of  a  fifteen  per  cent 
reserve,  as  heretofore,  upon  their  time  deposits.  We  have 
seen  from  our  review  of  the  testimony  of  the  countiy  bankers 
before  the  Congressional  committees,  that  it  is  unlikely 
that  the  country  banks,  as  a  whole,  will  run  their  reserve 
down  to  the  minimum  specified  in  the  law.  If  the  course 
indicated  by  the  above  calculation  be  pursued,  the  cash 
holdings  of  the  country  banks,  as  against  their  net  deposits, 
would  be  reduced  from  the  present  level  of  7.91  per  cent  to 
the  minimum  of  4.05  per  cent  permitted  by  the  new  law. 
It  is  very  improbable  that  the  cash  holdings  will  be  reduced 
to  this  minimum  for  years,  if  ever;  and  if  they  are  re- 
duced it  will  probably  not  be  until  the  reserve  banks  have 
built  up  their  organization  for  handling  the  clearing  of 
checks  and  drafts  and  until  the  greater  proportion  of  the 
State  banks  have  become  members  of  the  system.  This  will 
extend  the  sway  of  the  reserve  banks  over  practically  every 
important  institution  in  the  country,  and  enable  them  to 
clear  checks  no  matter  upon  what  bank  they  may  be  drawn. 
Most  important  of  all,  it  is  very  unlikely  that  the  country 
banks  will  cut  their  cash  reserves  in  half  until  they  have  had 
one  or  more  impressive  demonstrations  of  the  efficacy  of 
the  system  in  time  of  stress,  and  until  time  has  erased  the 
painful  recollections  of  the  folly  of  relying  upon  the  de- 
posited reserve. 

The  question  which  confronts  us,  therefore,  in  our  cal- 
culation— which  aunin  it  must  bo  rciiiarkod  is  purely  sug- 
gestive and  intended  to  be  nothing  more  than  an  analysis 
of  the  rather  imperfect  information  at  hand — is  what  will 
probably  be  the  withdrawals  of  the  country  banks  from 
17 


258       OPERATION  OF  THE  NEW  BANK  ACT 

their  reserve  agents  ?  On  the  one  hand,  they  may  withdraw 
the  entire  amount  from  the  reserve  agents.  If  they  should 
do  so,  they  would  not  only  be  within  their  legal  rights,  but 
they  would  still  not  have  reduced  their  deposited  reserve  be- 
low the  legal  minimum.  In  order  to  keep  a  fifteen  per  cent 
reserve  the  country  banks,  with  their  present  cash  holdings, 
must  have  balances  with  reserve  agents  aggregating  $287,- 
473,364.90.  Their  balances  actually  were  $533,253,765.18. 
With  the  total  requirement  for  payments  aggregating  only 
$217,131,591.10,  it  is  evident  that  the  country  banks  need 
have  no  fear  of  being  required  to  make  sacrifices  or  curtail 
accommodations  to  their  local  customers. 

What  Proportion  of  the  Present  Reserve  Balances 
Will  Remain? — It  is,  however,  unlikely,  as  has  already  been 
developed,  that  the  country  banks  will  withdraw  all  of  their 
balances  with  their  reserve  agents  because  of  the  necessity 
of  preserving  their  present  channels  of  collections  and  sell- 
ing exchange.  Our  problem,  therefore,  narrows  down  to 
this :  First,  the  country  banks  can  in  all  probability  finance 
the  shifting  of  reserves  required  in  the  first  year  from  the 
surplus  cash  in  their  own  vaults  released  by  the  new  re- 
quirements, if  they  so  desire.  It  is  unlikely  that  they  wiD 
do  this.  Second,  the  country  banks  may  raise  the  entire 
amount  of  their  payments  for  capital,  transferring  United 
States  deposits  and  reserves  by  withdrawals  of  a  part  of 
their  deposits  with  reserve  agents.  This  is  entirely  fea- 
sible, unless  it  will  deprive  them  of  their  exchange  and  col- 
lection privileges.  The  withdrawals  from  reserve  agents 
of  the  amounts  needed  for  the  payments  ought  not  to  cause 
any  loss  of  exchange  privileges,  since  the  country  banks 
have  an  excess  of  $406,438,043.  This  should  preserve  the 
major  portion  of  their  present  exchange  privileges.  We 
must  remember  also  that  the  reserve  banks  should  speedily 
offer  excellent  exchange  and  collection  facilities  to  their 
customers.  Third,  as  a  more  or  less  arbitrary  conclusion, 
but  one  which  will  probably  more  nearly  accord  with  the 
facts,  we  may  assume  that  the  country  banks  will  adopt  a 
middle  course,  withdrawing  one-half  of  their  payments  from 


RESERVES  IN  COUNTRY  BANKS 


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260       OrERATION  OF  THE  NEW  BANK  ACT 

their  vaults  and  the  other  one-half  from  their  reserve 
agents,  dividing  this  withdrawal  equally  between  the  re- 
serve cities  and  the  central  reserve  cities.  Upon  the  basis 
of  the  second  and  third  assumptions  let  us  calculate  the 
effect  of  the  Reserve  Act  upon  the  country  banks  at  the  end 
of  the  first  year. 

Upon  the  basis  of  the  assumption  that  we  have  made  to 
illustrate  the  problem  of  shifting  the  cash  reserv^es  as  it 
affects  the  country  banks,  we  find,  to  summarize,  that  the 
maximum  Anthdrawals,  up  until  the  thirteenth  month,  under 
the  worst  conditions  that  can  be  anticipated  for  the  coun- 
try banks  will  be  something  under  $127,000,000,  as  con- 
trasted with  reserve  balances  of  these  institutions  of  up- 
wards of  $533,000,000.  Therefore,  country  banks'  balances 
which  would  remain  with  the  reserve  agents,  if  they  so 
elect,  would  in  no  case  be  less  than  $406,000,000;  while 
under  the  most  favorable  conditions,  and  upon  the  pre- 
sumption that  the  country  banks  will  run  their  cash  hold- 
ings down  to  the  lowest  point,  using  this  money  as  far  as 
it  will  go  to  finance  their  requirements,  the  amount  remain- 
ing on  deposit  with  their  reserve  agents  at  the  end  of  the 
thirtieth  month  may  be  $435,065,373.20.  The  withdrawals 
which  country  banks  will  make  from  the  present  reserve 
agents  will  aggregate  somewhere  between  $98,188,391.98 
and  $217,131,591.10.  This  is  upon  the  presumption  that 
the  country  banks  will  not  entirely  withdraw  their  balances, 
but  will  allow  such  portion  thereof  to  remain  as  is  not  abso- 
lutely needed  in  financing  payments  to  the  Federal  reserve 
banks. 

It  seems  probable  that  the  most  accurate  assumption  is 
that  in  which  the  country  banks  will  partly  reduce  their 
cash,  making,  at  a  rough  estimate,  one-half  of  the  payments 
to  the  Federal  reserve  banks  out  of  the  surplus  cash  hold- 
ings and  withdrawing  the  balance  from  their  reserve  agents. 
In  this  event  the  withdrawal  of  the  country'  banks  would  be 
something  over  $108,000,000.  Under  this  assumption  the 
balance  which  the  country  banks  would  leave  with  the  re- 
serve agents  would  exceed  $424,000,000.     Even  under  the 


RESERVES  IN  COUNTRY  BANKS  2G1 

most  unfavorable  assumption  which  we  have  made  the  bal- 
ances would  exceed  $316,000,000.  In  other  words,  the  many 
statements  that  have  been  made  that  the  new  plan  will  im- 
mediately take  the  country  money  from  the  reserve  centers, 
are  fallacious.  In  so  far  as  the  requirements  of  the  law 
are  concerned,  the  country  banks,  if  they  should  so  elect,  will 
be  permitted  to  keep  throughout  the  three-year  period  of 
adjustment,  in  which  the  new  exchange  and  collection  facil- 
ities should  certainly  have  had  time  to  develop,  at  least 
$300,000,000  on  deposit  with  the  existing  resers'e  agents ; 
which  would  be  ample,  in  all  probability,  to  preserve  their 
present  channels  of  selling  exchange  and  handling  collec- 
tions, and  render  them  independent  as  regards  the  success 
of  the  Federal  reserve  plan  of  collection. 

Will  it  Pay  the  Country  Banks  to  Retain  a  Part  of 
their  Present  Reserve  Balances? — Of  course  when  the 
final  stage  in  the  readjustment  of  the  reserves  of  the  coun- 
try banks  is  reached,  at  the  end  of  the  thirty-six-month 
period,  this  surplus  balance  will  be  very  considerably  re- 
duced. How  much  will  remain  after  the  final  step  in  the 
adjustment  is  completed  we  must  leave  for  discussion  in 
a  later  chapter.  It  is  important  to  remember,  however,  that 
during  the  first  three  years  there  will  probably  remain  in 
the  reserve  cities  and  central  reserve  cities  some  $300,000,- 
000  of  "country  money." 


CHAPTER  XXIII 
Readjustment  of  Reserves  in  the  Reserve  Cities 

Position  of  Reserve  Cities. — Next  to  the  country  banks 
the  reserve  city  banks  are  in  the  strongest  position  to  meet 
the  problems  which  must  be  solved  in  the  readjustment  of 
reserves  under  the  Federal  Reserve  Act.  The  reserve  city 
banks,  according  to  the  latest  report  made  by  the  Comp- 
troller of  the  Currency,  counted  among  their  resources  ' '  due 
from  approved  reserve  agents,"  $257,833,661.11 ;  "due  from 
national  banks  (not  reserve  agents),"  $226,569,970.46;  and 
due  from  "State  banks  and  bankers,  trust  companies,  etc.," 
$102,058,079.75,  making  a  total  of  $586,461,711.32.  At  the 
same  time  they  counted  among  their  liabilities  "due  to 
national  banks  (not  reserve  agents) , ' '  $430,443,763.77  ; ' '  due 
to  State  banks  and  bankers, "  $225,543,075.93 ;  "due  to  trust 
companies  and  savings  banks,"  $226,732,449.31;  and  "due 
to  approved  reserve  agents,"  $35,905,417.90,  making  a  total 
of  $918,624,706.91.  It  will  be  seen  that  the  reserve  city 
banks,  in  spite  of  their  large  balances  on  deposit  with  cen- 
tral reserve  city  institutions,  still  owed  more  to  bankers  than 
they  had  the  right  to  receive,  the  net  debit  balance  against 
them  being  $332,162,995.59,  against  which  their  holdings 
of  le'gals  and  specie  aggregated  $242,316,766.39.  Upon  this 
basis  it  would  seem  that  the  reserve  city  banks  would  have 
to  depend  almost  entirely  upon  central  reserve  city  institu- 
tions to  supply  the  funds  which  would  be  necessary  to  enable 
them  to  meet  the  requirements  of  the  Federal  Reserve  Act. 
Such  a  method  of  comparison,  however,  is  not  the  correct 
way  in  which  to  judge  this  problem,  and  it  is  inserted  here 
simply  for  the  purpose  of  pointing  out  a  fallacy  into  which 
the  reader  could  readily  fall. 

The  balances  which  the  reserve  city  banks  are  carrying 
with  national  banks  (not  reserve  agents)  are  at  the  present 
time  necessary,  being  kept  to  enable  them  to  handle  their 

262 


RESERVES  IN  RESERVE  CITIES  263 

exchange  and  collection  business.  A  bank  in  Los  Angeles, 
M'hich  is  a  reserve  city,  may  carry  a  balance  with  a  bank 
in  Philadelphia,  also  a  reserve  city.  It  is  impossible  for  the 
Los  Angeles  bank  to  count  the  Philadelphia  balance  as  a 
part  of  its  reserve;  but  the  carrying  of  such  a  balance  is 
warranted  because  it  enables  the  Los  Angeles  bank  quickly 
and  cheaply  to  handle  Eastern  collections  and  sell  exchange. 

Significance  of  Clearing  and  Collection  Problem. — 
If  the  Federal  reserve  banks  will  offer  facilities  for  collec- 
tion and  selling  exchange  as  good  or  better  than  those  now 
existing,  these  balances  will  be  released,  since  the  motive  for 
keeping  them  will  have  disappeared.  To  what  extent  the 
Federal  reserve  banks  will  be  able  to  bring  about  this  result 
is  a  matter  which  is  discussed  in  the  chapter  on  "Clearing 
Checks  and  Drafts."  At  this  point,  however,  it  should  be 
remarked,  in  order  to  clarify  the  discussion  which  follows, 
that  it  may  take  a  considerable  period  of  time — perhaps 
years — to  build  up  these  facilities;  and  that,  therefore,  to 
assume  that  the  reserve  city  banks  can  at  once  withdraw 
these  balances  would  be  to  ignore  the  mandates  of  good 
business  practice  and  to  render  valueless  the  entire  cal- 
culation. 

The  same  general  condition  exists  as  regards  the  re- 
sources known  as  "due  from  State  banks  and  bankers,  trust 
companies,  etc."  A  considerable  proportion  of  these  items, 
as  well  as  the  item  "due  from  national  banks  (not  reserve 
agents),"  represents  deposits  which  are  kept  for  busineas 
reasons,  while  the  balance  of  these  items  is  checks  dra^^'n 
upon  these  institutions,  which  the  reserve  city  bank  has  in 
the  process  of  collection  at  the  time  the  statement  is  fur- 
nished to  the  Comptroller.  The  deposits  with  approved 
reserve  agents  may  be  withdrawn  so  long  as  their  with- 
drawal does  not  interfere  with  the  collection  or  exchange 
business  of  the  reserve  city  banks.  Doulitless  they  will 
be  reduced  as  much  as  necessary,  to  enable  the  reserve  city 
banks  to  finance  their  payments  to  the  Federal  reserve 
banks. 


264       OPERATION  OF  THE  NEW  BANK  ACT 

Relation  of  State  Banks  to  Reserve  City  Problem. — A 
similar  analysis  of  the  liabilities  of  the  reserve  city  banks 
shows  much  the  same  results.  The  item  "due  to  national 
banks  (not  reserve  agents)  "  is  to  be  explained  in  part  by  bal- 
ances which  other  national  banks  are  carrying  with  these 
reserve  city  institutions  for  collection  and  exchange  pur- 
poses, and  in  part  by  the  sums  which  the  reserve  city  banks 
owe  to  other  national  banks,  not  reserve  agents,  for  items 
which  are  in  the  process  of  collection.  The  deposits  repre- 
sented by  the  item  "due  to  trust  companies  and  savings 
banks"  will  in  no  way  be  ajffected  by  the  Federal  Reserve 
Act,  unless  the  State  banks  and  trust  companies,  which  are 
carrying  these  balances,  should  go  into  the  Federal  Reserve 
system. 

In  the  calculations  for  the  reserve  cities  and  central 
reserve  cities,  it  should  be  remarked  that  no  account  has 
been  taken  of  any  withdrawals  from  these  cities  resulting 
from  the  State  banks  joining  the  Federal  Reserve  system. 
The  problem  has  been  confined  entirely  to  the  national  banks, 
largely  because  the  statistics  relating  to  State  banks  are  so 
incomplete  that  any  accurate  opinion  of  the  effect  that 
they  will  have  upon  the  system  is  impossible.  Moreover, 
the  extent  to  which  the  State  banks  will  enter  during  the  first 
thirty  months  is  so  problematical  that  any  assumptions 
would  be  valueless.  If  the  great  majority  of  State  banks 
should  join  promptly,  the  load  which  their  action  will  throw 
upon  the  reserve  city  and  central  reserve  city  banks  will  be 
very  much  larger  than  if  the  new  system  is  confined  at  the 
outset  almost  entirely  to  the  national  banks. 

As  a  general  conclusion  it  may  be  safely  said  that,  in  all 
probability,  practically  all  of  the  national  banks  will  enter 
the  system,  while  a  comparatively  small  proportion  of  the 
State  banks  will  subscribe  to  the  stock  of  the  Federal  reserve 
banks  and  accept  the  provisions  of  the  Act.  If  a  large  pro- 
portion of  the  State  institutions  stay  out  of  the  Federal 
reserve  system,  it  is  unlikely  that  they  will  withdraw  their 
balances  from  their  present  reserve  agents,  that  is  to  say, 


RESERVES  IN  RESERVE  CITIES  265 

from  the  reserve  city  and  central  reserve  city  banks.  This 
liability  will  to  a  large  degree  be  allowed  to  continue. 

Not  all  Reserve  Cities  Will  Be  Alike  Affected. — Looked 
at  from  another  point  of  view,  the  problem  of  the  shifting 
of  the  reserves  of  the  reserve  city  banks  is  not  so  serious 
as  would  be  indicated  by  the  preceding  general  comparison. 
It  is  practically  certain  that  the  three  central  reserve  cities 
will  be  selected  for  the  establishment  of  Federal  reserve 
banks;  and  it  is  equally  certain  that  the  remaining  reserve 
banks — five  in  number,  if  eight  are  established,  and  nine  in 
number  if  the  maximum  of  twelve  are  established — will  be 
located  in  the  reserve  cities.  In  other  words,  from  five  to 
nine  of  the  forty-seven  reserve  cities  will  be  the  homes  of 
the  Federal  reserve  banks,  and  the  fortunate  cities  will  prob- 
ably be  numbered  among  the  larger  of  the  forty-seven.  It 
is  true  that  this  does  not  help  any  individual  bank,  for  its 
payments  will  be  just  as  large  and  the  withdrawals  of  cash 
from  it  just  as  great,  whether  the  Federal  reserve  bank  is 
located  across  the  street  or  whether  it  is  a  hundred  miles 
away;  but  in  so  far  as  the  district  is  concerned  and  the  busi- 
ness men  of  these  cities  are  involved,  we  must  remember  that 
this  money  will  not  be  withdrawn  from  the  majority  of  these 
cities,  but  simply  transferred  from  one  class  of  institutions 
to  another.  The  new  Federal  reserve  banks  will  be  willing 
and  prepared  to  lend  this  money  out  to  the  member  banks — 
perhaps  to  the  same  ones  and  in  the  same  proportion  in  which 
it  was  contributed — upon  the  production  of  satisfactory 
commercial  paper  for  rediscount.  These  considerations  are 
rea.ssuring  in  case  we  should  find  that  the  reserve  city  insti- 
tutions would  be  hard  pressed  to  raise  their  contributions, 
and  that  their  balances  with  their  reserve  agents  were  not 
sufficient,  together  with  the  cash  which  they  have  on  hand, 
to  enable  thorn  to  moot  the  retiuirements  of  the  Act. 

New  Reserve  Requirements. — Under  the  provisions  of 
the  National  Bank  Act,  the  reserve  city  banl<s,  as  we  remem- 
ber, were  required  to  keep  a  minimum  reserve  equal  to 
twenty-five  per  cent  of  their  deposits.  By  deposits  are 
meant  not  only  the  individual  deposits  with  the  bank  but 


266       OPERATION  OF  THE  NEW  BANK  ACT 

bankers'  deposits,  representing  such  sums  as  are  carried 
with  reserve  city  institutions  by  country  banlcs  and  other 
banking  institutions.  Of  the  twenty-five  per  cent  reserve 
required  by  the  reserve  city  banks,  one-half  must  be  kept 
in  cash  in  the  bank's  own  vaults  while  the  other  half  may 
be  deposited  with  approved  reserve  agents  in  central  reserve 
cities.  The  reserve  requirements  for  the  reserve  city  banks 
are  radically  changed  by  the  Federal  Reserve  Act.  The 
provisions  of  the  law  governing  this  matter  are  as  follows : 

"A  bank  in  a  reserve  city,  as  now  or  hereafter  defined, 
shall  hold  and  maintain  reserves  equal  to  fifteen  per  centum 
of  the  aggregate  amount  of  its  demand  deposits  and  five  per 
centum  of  its  time  deposits,  as  follows: 

''In  its  vaults  for  a  period  of  thirty-six  months  after 
said  date  six-fifteenths  thereof,  and  permanentlj  thereafter 
five-fifteenths. 

"  In  the  Federal  reserve  bank  of  its  district  for  a  period 
of  twelve  months  after  the  date  aforesaid  at  least  three- 
fifteenths,  and  for  each  succeeding  six  months  an  additional 
one-fifteenth  until  six-fifteenths  have  been  so  deposited, 
which  shall  be  the  amount  permanently  required. 

"For  a  period  of  thirty-six  months  after  said  date  the 
balance  of  the  reserves  may  be  held  in  its  own  vaults,  or  in 
the  Federal  [reserve  bank,  or]*  in  national  banks  in  reserve 
or  central  reserve  cities  as  now  defined  by  law. 

"After  said  thirty-six  months'  period  all  of  said  re- 
serves, except  those  hereinbefore  required  to  be  held  per- 
manently in  the  vaults  of  the  member  bank  and  in  the 
Federal  reserve  bank,  shall  be  held  in  its  vaults  or  in  the 
Federal  reserve  bank,  or  in  both,  at  the  option  of  the 
member  bank." 

Perhaps  the  following  summary  of  the  provisions  of  the 
Act  above  quoted  will  help  to  fix  it  in  the  reader's  memory: 

Reserve  city  banks  shall  hold  reserves: 

1.  Of  15  per  cent  on  demand  deposits. 

2.  Of  5  per  cent  on  time  deposits. 

This  reserve  is  to  be  segregated  as  follows : 

*  The  words  in  brackets  were  stricken  out  by  amendment  effective 
August  15,  1914. 


RESERVES  IN  RESERVE  CITIES 


'267 


12 

18 

24 

30 

36 

mos. 

mo8. 

mos. 

mos. 

mos. 

6/15 

6/15 

6/15 

6/15 

6/15 

3/15 

4/15 

5/15 

6/15 

6/15 

A 

A 

A 

A 

A 

There- 
after. 


In  vaults  (compulsory) 

In  Federal  reserve  banks  (compul- 
sory)   

Balance  of  required  reserve  may 
be  held  as  shown  by  appropri- 
ate footnote 


5/15 
6/15 


A.  The  remainder  to  be  held  for  the  first  36  months  in  either  the  bank's  vault, 
in  the  reserve  banks  or  with  reserve  agents  in  reserve  or  central  reserve  cities  aa  the 
bank  may  elect. 

B.  Thereafter  it  may  be  held  in  the  bank's  vaults  or  in  the  reserve  banks  but 
may  not  be  deposited  with  present  reserve  agents. 

Probable  Results  if  Country  Banks  Withdraw  the 
Minimum. — lu  dealing  with  the  problem  of  the  reserve 
city  banks,  we  shall  follow  practically  the  same  plan  which 
we  have  pursued  in  investigating  the  effect  of  the  law  upon 
the  countiy  institutions.  Our  first  inquiry  is  based  upon  the 
assumption  which  we  made  concerning  the  country  banks, — 
that  they  will  finance  their  payments  to  the  Federal  reserve 
banks  so  far  as  possible  out  of  their  surplus  cash  holdings, 
running  them  down  to  the  legal  minimum  and  drawing  upon 
the  central  reserve  institutions  for  as  little  as  possible.  We 
assume,  moreover,  throughout,  that  the  withdrawals  of  the 
country  banks,  wherever  necessary,  are  divided  between  the 
reserve  city  banks  on  the  one  hand  and  the  central  reserve 
city  banks  on  the  other,  each  class  putting  up  an  equal 
amount.  The  result  of  our  investigation  of  the  country 
banks  shows  that,  under  this  assumption,  the  deficit  which 
must  be  met  by  withdrawals  from  the  reserve  city  and  the 
central  reserve  city  banks  during  the  first  year  is  the  insig- 
nificant sum  of  $7,872,522.38,  which  would  be  divided 
equally  between  the  reserve  city  and  central  reserve  city 
banks,  making  .$3,936,261.19  to  be  withdrawn  from  the 
reserve  city  institutions  during  the  first  year.  At  the  point 
where  the  required  cash  payments  to  the  reserve  banks  will 
reach  their  maximum  strain  at  the  beginning  of  the  twenty- 
fifth  month,  the  deficit  which  would  have  to  be  withdra^^^l 
from  the  reserve  agents  would  be  $98,188,391.98,  making 
the  contrihution  of  the  reserve  city  banks  $49,094,195.99. 


268       OPERATION  OF  THE  NEW  BANK  ACT 

RESERVE  CITY  BANKS  (314). 

Reserve  Requirements:     15  Per  Cent  of  Demand  Deposits  and  5  Per  Cent 
OF  Time  Deposits. 

Assuming  that  one-half  of  the  deficit  of  the  country  banks  is  withdrawn  from  the 
reserve  city  banks.    Nothing  withdrawn  in  first  year  (see  previous  chapter). 


12 

mos. 

18 
mos. 

24 

mos. 

30 
mos. 

36 
mos. 

6/15 
3/15 

6/15 
4/15 

6/15 
6/15 

6/15 
6/15 

6/15 
6/15 

In  Federal  reserve  banks  (compulsory) . . 

The  remainder  to  be  held  for  first  thirty-six  months  either  in  the  bank's  vault, 
on  deposit  with  reserve  banks  or  on  deposit  with  banks  in  central  reserve  cities. 


During  the 
first  year. 

Up  to  the  25th 

to  30th  month 

period. 

Net  deposits  subject  to  reserve  (Oct.  21,1913)- 

$1,915,160,396.96 
146,889,314.89 

*$1,866,066,200.97 

14fi.SS9.314  89 

$1,768,271,082  07     $1,719,176,886  08 

15  per  cent  reserve  on  demand  deposits 

5  per  cent  reserve  on  time  deposits 

$265,240,662.31 
7,344,465.74 

$257,876,532.91 
7.344.465.74 

Total  minimum  reserve  required 

$272,585,128.05 

$265,220,998.65 

Of  the  above  the  banks  must  keep  6/15  in 

$109,034,051.22 
54,517,025.61 

109,034,051.22 

$106,088,399.46 

On  deposit  with  Federal  reserve  banks 

The  balance  on  the  presumption  of  the  small- 
est amount  of  shifting  of  cash  would  re- 
main with  the  present  reserve  agents 

106,088,399.46 
53,044,199.73 

$272,585,128.05 

$265,220,998.65 

Lawful  money  in  reserve  city  banks 

New  minimum  cash  holdings  as  above 

$242,316,766.39 
109,034.051.22 

$242,316,766.39 
106.088.399.46 

$133,282,715.17 

$136,228,366.93 

Payments  of  reserve  city  banks  to  Federal 
banks: 

$54,517,025.61 

$106,088,399.46 

Subscription    to    stock — 3  per  cent  of 
their  «449, 196,920  capital  and  surplus 

13,475.907.60 

13.475.907.60 
49.094,195.99 
35.209.272  10 

35,209,272.10 

Total  payment  to  Federal  reserve  banks.  .  . 

$103,202,205.31         5203,867,775.15 
133,282,715.17           136,228.366.93 

Excess  cash  when  countrj'  banks  finance 

$30,080,509.86 

t$67.639,408.22 

*  Net  deposits  subject  to  reserve  requirements  on  October  21,  1913,  less  one- 
half  deficit  of  country  banks  withdrawn  amounting  to  $49,094,195.99. 
t  Deficit. 


RESERVES  IN  RESERVE  CITIES 


269 


During  the  first  year. 


Up  to  25tb  to  30th  month. 


Taking  all  from 
central  reserve  | 
banks  to  make 
payments  to 
Federal  reserve 
banks. 


resent    balance 
with    central    re-l 

serve  agents $257,833,661.11 

Payment  to  Federal 

reserve  banks 103,202.205.31 


Taking  one- 
half  from 
reserve  agent 
and  one-half 
from  vaults. 


Taking  all  from 
central  reserve 
banks  to  make 
payments  to 
Federal  reserve 
banks. 


Taking  one- 
half  from 
reserve  agents 
and  one-half 
from  vaults. 


$257,833,661.11  $257,833,601.11]  $257,833,661.11 
51,601.102.66     203.867.775.15      101.933,887.58 


Excess  balances  with  ,  

reserve  agents. . . ;  $154,631,455.80  $206,232,558.45,    $53,965,885,961  $155,899,773.53 


The  withdrawals  by  the  country  banks  during  the  first 
year  are  small,  and  as  they  could  easily  be  offset  by  United 
States  deposits,  we  assume  in  the  first  part  of  our  calculation 
that  nothing  is  withdrawn  from  the  reserve  cities.  The 
$49,094,195.99  withdrawn  by  the  country  banks  up  to  the 
beginning  of  the  twenty-fifth  month  is  taken  care  of  by  a 
deduction  of  this  amount  from  the  net  deposits  subject  to 
reserve.  Using  this  as  the  basis  of  the  calculation,  the 
effect  upon  the  reserve  city  banks  would  be  as  is  sho^vn  on 
the  preceding  page. 

It  is  plain  that  the  reserve  city  banks,  at  the  very  begin- 
ning, Avill  have  liberated  through  the  lower  reserve  require- 
ments practically  as  much  cash  as  they  will  ever  have  at  their 
disposal.  If  they  use  it,  as  we  have  presumed,  to  finance 
themselves  during  the  first  twelve  months,  it  will  simply 
postpone  for  one  year  the  ultimate  demands  which  must  be 
made  upon  the  central  reserve  city  banks  in  succeeding 
periods.  Thus,  so  far  as  the  final  result  is  concerned,  it  makes 
no  difference  whether  the  reserve  city  banks  keep  their  cash, 
in  the  beginning,  dropping  before  the  twenty-fifth  month 
down  to  the  legal  minimum  ;  or  whether  they  drop  promptly 
to  the  new  level  and  postpone  their  demands  upon  the  cen- 
tral reserve  banks.  It  would  probably  be  better  in  the  long 
run  for  the  reserve  city  banks  gradually  to  reduce  their 
reserves.  This  would  lead  to  a  smaller  disturbance  of 
public  confidence,  and  would  be  better  banking,  for  a  sudden 


270      OPERATION  OF  THE  NEW  BANK  ACT 

change  is  never  desirable.  It  would  be  just  as  well  to  spread 
the  demand  upon  the  central  reserve  banks  over  as  long  a 
period  as  possible  in  order  to  allow  them  gradually  to  read- 
just their  affairs.  The  amount  which  the  reserve  city  banks 
must  deposit  with  the  Federal  reserve  banks  upon  the  in- 
auguration of  the  system  is  $54,517,025.62;  while  at  the 
point  where  the  required  cash  pajTnents  to  the  reserve  banks 
will  reach  their  maximum  stress,  at  the  beginning  of  the 
twenty-fifth  month,  the  deposits  with  the  reserve  banks  will 
aggregate  $106,088,399.46.  The  portion  of  the  balance 
which  the  reserve  city  banks  are  carrying  with  central  re- 
serve institutions,  and  which  they  can  for  thirty-six  months 
include  as  part  of  their  minimum  reserve,  is  something  over 
$109,000,000  at  the  beginning,  and  falls  to  a  little  over 
$53,000,000  by  the  twenty-fifth  month. 

The  most  important  feature  of  our  calculation  concerns 
the  ability  of  the  banks  to  finance  their  payments  on  the 
basis  of  the  assumption  upon  which  the  calculation  is  made, 
viz. :  that  the  country  banks  will  withdraw  nothing  so  long 
as  they  can  finance  themselves ;  and  that  when  the  payments 
which  they  must  make  to  the  Federal  reserve  banks  exceed 
their  surplus  cash,  they  will  withdraw  only  the  deficit,  this 
being  taken  in  equal  proportions  from  the  resei'\'e  city  and 
the  central  reserve  city  institutions. 

We  find  that,  during  the  first  year,  the  reserve  city  banks 
would  have  an  excess  of  cash  over  the  payments  which  they 
must  make  and  the  minimum  reserve  which  they  are  required 
to  keep,  of  something  over  $30,000,000;  and  that  by  the 
time  the  point  of  greatest  stress  as  regards  the  required  cash 
payments  to  the  reserve  banks,  between  the  twenty-fifth  and 
thirtieth  months,  has  been  reached,  there  would  be  a  deficit 
of  $67,639,408.22.  This  deficit  would  have  to  be  withdrawn 
from  the  central  reserve  city  institutions. 

Effect  on  Balances  with  Central  Reserve  City  Banks, — 
The  last  portion  of  the  above  calculation  shows  the  effect 
which  the  various  courses  of  action  would  have  upon  the 
balances  of  the  reserve  city  banks  with  their  reserve  agents. 


RESERVES  IN  RESERVE  CITIES  271 

If  they  should  take  all  of  their  payments  during  the  first 
year  from  central  reserve  city  banks,  they  would  reduce 
their  balances  from  a  little  less  than  $258,000,000  to  approxi- 
mately $155,000,000.  If  they  should  adopt  the  policy  of 
taking  half  of  their  payments  during  the  first  year  from 
their  reserve  agents  and  half  from  their  own  vaults,  their 
balance  would  be  reduced  to  approximately  $200,000,000. 

If  they  should  persist  in  the  policy  of  forcing  upon  their 
reserve  agents  the  burden  of  making  all  payments  to  the 
Federal  reserve  banks,  their  balances  with  their  reserve 
agents  will  be  reduced  by  the  twenty-fifth  month  to  about 
$54,000,000.  If  throughout  this  period  they  should  have 
followed  the  policy  of  furnishing  one-half  of  these  payments 
themselves  and  should  call  upon  the  reserve  agents  for  the 
rest,  their  balances  with  reserve  agents  would  be  approxi- 
mately $156,000,000  at  the  expiration  of  that  time. 

Results  if  the  Country  Banks  Withdraw  One-half  of 
Their  Payments. — Let  us  next  take  up  the  assumption  that 
the  country  banks  will  furnish  from  their  own  vaults  one- 
half  of  the  cash  for  the  payments  to  the  reserve  banks 
themselves  and  call  on  the  reserve  agents  for  the  balance, 
dividing  this  demand  equally  between  the  reserve  city  and 
the  central  reserve  city  banks.  In  this  event  the  needs  of 
the  reserve  city  banks  during  the  first  twelve  months  and  at 
the  time  of  greatest  stress,  as  regards  the  required  cash  pay- 
ments to  the  reserve  banks  from  the  twenty-fifth  to  the 
thirtieth  month,  would  be  as  is  shown  on  the  following  page. 

Upon  the  basis  of  these  assumptions,  we  see  that  the 
reserve  city  banks  during  the  first  year  would  just  be  able, 
financing  their  operations  as  far  as  possible  from  their  own 
vaults,  to  make  their  payments  to  the  Federal  resen'e  banks ; 
while  if  they  should  continue  this  general  policy  up  to  the 
twenty-fifth  month,  they  would  have  been  compelled,  up  to 
that  time,  to  have  withdrauni  approximately  $72,205,000 
from  the  central  reserve  citv  banks. 


272     opp:ration  of  the  new  bank  act 


RESERVE  CITY  BANKS. 

Assuming  that  country  banks  finance  themselves  for  one-half  of  Federal  reserve 
bank  payments  and  call  on  reserve  city  banks  and  central  reserve  city  banks 
(in  equal  amounts)  for  the  balance. 


During  the 

first  year. 

Up  to  25th  to  30th 
month  period. 

Net  deposits,  10/21/13 

$1,915,160,396.96     $1,915,160,396.96 

31,703,930.38  i          54,282,897.77 

$1,883,456,466.58     $1,860,877,499.19 

146,889,314.89  1         14f..SS9.314.S9 

$1,736,567,151.69 

$1,713,988,184  30 

15  per  cent  reserve  on  demand  deposits 

5  per  cent  reserve  on  time  deposits 

$260,485,072.75 
7,344,465.74 

$257,098,227.65 
7,344,465.74 

Total  minimum  reserve  required 

$267,829,538.49        $264,442,693.39 

Of  above  banks  must  keep  in  vaults 

And  on  deposit  with  Federal  reserve  banks. 
Balance  is  assumed  to  be  left  with  present 

$107,131,815.40 
53,565.907.70 

107,131,815.39 

$105,777,077.35 
105,777,077.36 

52,888,538.68 

$267,829,538.49 

$264,442,693.39 

$242,316,766.39 
107,131,815.40 

$242,316,766.39 

New  minimum  cash  reserve  requirements  as 

105,777,077.35 

Excess  available  for  Federal  bank  payments. 

$135,184,950.99 

$136,539,689.04 

Payments  to  be  made  to  Federal  bank: 

$53,565,907.70 
13,475,907.60 
35,209,272.10 
31,703,930.38 

$105,777,077.36 

13,475,907.60 

35,209,272.10 

Payment  account  country  deposits  (as  above) 

54,282,897.77 

Total  payments  to  Federal  reserve  banks.. . 

$133,955,017.78 
135,184.950.99 

$208,745,154.83 
136,539,689.04 

Surplus  cash  in  vaults 

$1,229,933.21 

*$72,205,465.79 

During  1st  year.                             25th  to  30th  month. 

Taking  one-half 

from  agents  and 

one-half  from 

vaults. 

T  i;    „    II  f-„„.    Taking  one-half 
a     nf  t^  l,T      from  reserve 
rfH.rll  uJ^lK     agents,  one-half 
Federal  banks.    f,Sm  own  vaults. 

Taking  all  from 
agents  to  pay 
Federal  banks. 

Present  balance  with 
reserve  agents .  .  . 

Payments    to    re- 
serve banks  with- 
drawn from  re- 
serve agents 

$257,833,661.11 
66,977,508.89 

$257,833,661.11   $257,833,661.11 

133,955,017.78     104,372,577.42 
$123,878,643.33  $153,461,083.69 

107,131,815.39       52,888.538.68 
$16,746,827.94  $100,572,545.01 

$257,833,661.11 
208,745,154.83 

Excess  remaining 
with  agents 

Balance  assumed  to 
be    left    with    re- 
serve agents 

$190,856,152.22 
107,131,815.39 

$49,088,506.28 
52,888.538.68 

Surplus  balance  with 
reserve  agents.  .  . 

Overdraft    of  b  a  1  - 
ances  with  reserve 
agents 

$83,724,336.83 

$3,800,032.40 

*  Deficit  to  be  drawn  from  central  reserve  cities. 


RESERVES  IN  RESERVE  CITIES  273 

Possible  Solutions  of  the  Problem. — Presuming  that 
the  country  banks  draw  on  their  resei*ve  agents  for  only  one- 
half  of  their  payments  to  the  Federal  reserve  banks,  dividing 
the  balance  in  equal  proportions  between  the  reserve  city 
banks  and  the  central  reserve  city  banks,  the  amount  of 
withdrawals  which  would  be  made  by  the  reserve  city  banks 
from  the  central  reserve  city  institutions  would  be  as 
follows : 

During  the  First  Year : 

(1)  If  the  reserve  city  banks  followed  the  example  of 
the  country  banks,  furnishing  one-half  of  their  payments 
from  their  o\\'n  vaults  and  drawing  upon  the  central  reserve 
banks  for  the  remainder,  they  would  reduce  their  accounts 
with  the  central  reserve  city  banks  to  approximately  $191,- 
000,000,  against  which  we  have  assumed  that  they  will  elect 
to  keep  $107,000,000  on  deposit  with  their  present  reserve 
agents  as  the  balance  of  the  reserve  required  under  the 
new  law.  This  would  leave  with  their  reserve  agents  slightly 
less  than  $84,000,000  above  the  minimum  requirements, 
which  they  could  use  as  they  see  fit. 

(2)  If  the  reserve  city  banks  should  insist  upon  with- 
drawing their  entire  payments  from  the  central  reserve 
city  institutions,  they  would  reduce  their  balance  from 
approximately  $258,000,000  to  about  $124,000,000.  Against 
this,  we  have  assumed  that  they  will  keep  a  balance,  repre- 
senting the  remainder  of  their  required  reserve  of  $107,- 
000,000  with  their  present  reserve  agents,  leaving  with  their 
reserve  agents  a  surplus  above  requirements  which  they  have 
at  their  disposal  of  something  less  than  $17,000,000. 

At  the  Period  of  Greatest  Stress,  as  Regards  the  Re- 
quired Cash  Payments  to  the  Reserve  Banks : 

(1)  If  the  reserve  city  banks  follow  the  policy  we  have 
assumed  for  the  country^  banks,  of  furnishing  one-half  of  the 
cash  themselves  and  drawing  the  balance  from  their  reserve 
agents,  they  will  reduce  their  balances  to  approximately 
$153,000,000,  against  which  they  will  keep  with  their  reserve 
agents  the  optional  portion  of  their  required  reserve  under 
the  new  law.  At  that  time,  this  will  amount  to  something 
18 


274       OPERATION  OF  THE  NEW  BANK  ACT 

less  thau  $53,000,000.  This  would  leave  them  a  surplus  bal- 
ance with  reserve  agents  of  $101,000,000  above  the  minimum 
requirements,  which  they  can  dispose  of  as  they  see  fit. 

(2)  If  the  reserve  city  banks  withdrew  their  entire  pay- 
ments from  their  central  reserve  agents,  they  would  reduce 
their  balances  to  about  $49,000,000.  But  we  have  presumed 
in  our  calculation  that  the  reserve  city  banks  will  keep 
approximately  $53,000,000  on  deposit  with  their  present 
reserve  agents,  this  representing  the  optional  portion  of  their 
reserves  which,  between  the  twenty-fifth  and  thirtieth 
months,  they  may  carry  with  reserve  agents  if  they  so  elect. 
Upon  this  basis,  there  would  be  an  overdraft  of  their  reserve 
account '  of  $3,800,032.40.  In  other  words,  it  would  be 
impossible  for  the  reserve  city  banks  to  follow  out  this  plan 
of  forcing  the  entire  burden  upon  the  central  reserve  city 
institutions.  They  could,  however,  if  they  so  elected,  with- 
draw their  entire  deposit  from  the  central  reserve  citj'  banks, 
depositing  it  with  the  Federal  reserve  banks.  Although  they 
would  have  no  balance  with  their  present  reserve  agents, 
they  would,  nevertheless,  still  have  a  sufficient  cash  reserve 
to  meet  the  requirement  of  the  law,  for  instead  of  carrj^ing 
$105,777,077.36,  the  minimum  according  to  the  Act,  their 
cash  holdings  would  be  $242,316,766.39.  Thus  their  resen^e 
would  be  much  more  than  sufficient,  since  it  is  optional  with 
them  to  keep  all  or  any  part  of  the  amount  which  we  have 
heretofore  presumed  would  be  left  with  the  reserve  agents, 
either  with  the  latter,  in  their  own  vaults,  or  with  the 
Federal  reserve  banlcs. 

What  Will  Happen  if  the  Country  Banks  Force  the 
Entire  Burden  on  the  Others? — Finally  there  remains  for 
consideration  the  assumption  that  the  countiy  banks  will 
refuse  to  reduce  their  cash  holdings  in  making  payments  to 
the  Federal  reserve  banks,  securing  their  entire  contribution 
by  drawing  in  equal  proportions  upon  reserve  agents  in  re- 
serve cities  and  central  resei-ve  cities  respectiveh' ;  and  that 
the  reserve  city  banks  themselves  will  hold  the  minimum 
cash  reserves  in  their  own  vaults  and  in  the  reserve  banks, 
the  balance  being  kept  with  their  central  reserve  agents. 
The  result  would  be  as  follows: 


RESERVES  IN  RESERVE  CITIES 


275 


RESERVE  CITY  BANKS. 

Assutninf;  that  country  banks  withdraw  one-half  of  entire  amount  of  their  payment 
to  Federal  reserve  bank  from  reserve  city  banks;  and  remainder  from  central 
reserve  city  banks. 


During  the  first 
twelve  months. 

Up  to  the  25th 

to  30th  month 

period. 

Net  deposits  (Oct.  21.  1913) 

Less  country  bank  withdrawals 

$1,915,160,396.96 
63.407.860.75 

$1,915,160,396.96 
108.565.795.55 

$1,851,752,536.21 

$1,806,594,601.41 

146,889.314.89           146.889.314.89 

$1,704,863,221.32 

«1. 659.705.286.52 

15  per  cent  reserve  on  demand  deposits 

5  per  cent  reserve  on  time  deposits 

$255,729,483.20 
7,344.465.74 

$263,073,948.94 

$248,955,792.98 
7.344.465.74 

Total  minimum  reserve  requirements.  . 

$256,300,258.72 

Of  above  banks  must  keep  in  their  vaults.  . 

And  in  Federal  banks 

Balance  on  presumption  of  smallest  with- 
drawal of  cash  from  central  reserve  cities, 
assumed  to  be  left  with  present  reserve 
agents 

$105,229,579.58        $102,520,103.49 
52.614.789.78           102,520,103.49 

105,229.579.58            51.260.051.74 

$263,073,948.94        $256,300,258.72 

Present  cash  holdincs 

$242,316,766.39        $242,316,766.39 

105.229.579.58  '        102.520.103.49 

Excess  available  for  Federal  bank  payments. 

$137,087,186.81 

$139,796,662.90 

Payments  of  reserve  city  banks  to  Federal 
banks: 

Reserve  (as  above) 

Subscription  to  stock 

United  States  deposits 

Payment  account  country  deposits  (as  above) 

$52,614,789.78 
13.475.907.60 
35.209.272.10 
63.407.860.75 

$102,520,103.49 

13,475,907.60 

35,209.272.10 

108.565.795.55 

Total  payments  to  Federal  reserve  banks. .  . 

$164,707,830.23 
137.087.186.81 

$27,620,643.42 

$259,771,078.74 
139,796,662.90 

Deficit . 

$119,974,415.84 

To  be  withdrawn  from  central  reserve  cities 
Against  which  they  have  balances 

$27,620,643.42  !      $119,974,415.84 
257.833.661.11           257.833.661.11 

$230,213,017.69 

Credit  balance  remaining  with  agents. . 

$137,859,245.27 

Summarizing  the  results  secured  from  the  foregoing  com- 
putation, the  following  analysis  is  presented,  which  shows 
the  withdrawals  and  the  balances  which  the  reserve  city 
banks  have  on  deposit  with  their  central  reserve  agents, 
where  they  in  turn  talce  all  of  their  payments  to  the  Fed- 
eral reserve  banks  from  their  reserve  agents,  and  wlien^  they 
procure  one-half  of  such  payments  in  this  iiiaiinci- : 


276       OPERATION  OF  THE  NEW  BANK  ACT 


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RESERVES  IN  RESERVE  CITIES  277 

It  should  be  borne  in  mind  that  the  above  analysis  is 
based  upon  the  assumption  that  the  country  banks  have 
forced  upon  the  reserve  city  banks  and  the  central  reserve 
city  banks,  equally,  the  burden  of  financing  their  payments 
to  the  Federal  reserve  banks.  If  the  reserve  city  banks  adopt 
a  more  liberal  attitude  than  their  country  brethren,  and 
furnish  one-half  of  their  payments  from  their  own  vaults, 
calling  upon  the  central  reserve  institutions  for  the  balance, 
we  find  that  the  balances  with  their  reserve  agents  are  suffi- 
cient for  the  purpose.  As  a  matter  of  fact,  even  should  they 
adopt  this  course,  they  would  still  have  a  surplus  balance, 
over  and  above  the  required  withdrawals,  of  over  $70,- 
000,000.  In  the  period  of  greatest  stress,  as  regards  the 
required  cash  payments  to  the  reserve  banks,  in  the  twenty- 
fifth  month,  the  balance  would  be  much  larger,  amounting 
to  almost  $77,000,000. 

On  the  other  hand,  if  we  assume  that  the  reserve  city 
banks  should  take  the  stand  that  we  have  assumed  for  the 
country  banks,  i.e.,  of  drawing  their  entire  payments  from 
the  central  reserve  institutions,  we  find  that  they  would 
overdraw  their  accounts  Avith  the  central  reserve  institutions. 
The  overdraft  during  the  first  twelve  months  would  amount 
to  something  over  $12,000,000,  while  by  the  time  the  twenty- 
fifth  month  had  been  reached  the  overdraft  would  have  been 
over  $53,000,000. 

During  the  first  year  this  overdraft  might  be  financed 
by  rediscounts  or  in  some  other  manner ;  but  by  the  twenty- 
fifth  month,  if  this  plan  were  followed,  the  whole  theory'  of 
this  particular  calculation  would  have  fallen.  The  amount 
of  the  overdraft  is  greater  by  some  $2,000,000  than  the 
optional  balance  of  throe-fifteenths  which,  at  that  time,  the 
reserve  city  banks  may  keep  in  their  own  vaults,  with  the 
Federal  reserve  banks,  or  with  their  present  reserve  agents. 
If  they  should  rediscount  the  entire  amount  of  the  over- 
draft ($53,000,000),  they  would  thereby  have  elected  to 
keep  this  optional  balance,  not  with  their  present  reserve 
agents,  but  willi  the  Federal  reserve  banks,  and  would  bave 
extinguished  their  balances  with  their  central  reserve  agents. 


278       OPERATION  OF  THE  NEW  BANK  ACT 

What  Will  Probably  Be  the  Course  Followed?— Which 
one  of  the  foregoing  assumptions  with  reference  to  the 
reserve  city  banks  will  most  nearly  accord  with  the  facts? 
Time  alone  can  tell.  To  presume  that  the  country  banks  and 
the  reserve  city  banks  will  both  insist  upon  maintaining 
intact  their  present  cash  balances  is  rather  fanciful.  These 
balances  have  been  running  up  to  a  high  figure  in  antici- 
pation of  a  reorganization  of  the  banlving  system,  and  there 
is  no  good  business  reason  to  support  the  assumption  that 
the  reserve  city  banks  or  the  country  banks  will  insist  upon 
preserving  them  as  they  are.  In  all  probability,  the  country 
banks  will  be  more  inclined  to  preserve  a  large  cash  balance 
than  the  reserve  city  institutions,  because  they  have  always 
done  so.  The  reserve  city  banks,  as  a  class,  have  heretofore 
kept  practically  nothing  above  the  legal  minimum.  The 
people  of  the  reserve  cities  are  accustomed  to  seeing  their 
banks  keep  practically  the  lowest  amount  of  cash  which  is 
permissible ;  and  the  reduction  to  the  new  level,  in  the 
absence  of  some  defect  in  the  law  or  some  industrial  or 
financial  disturbance,  can  probably  be  made  without  arous- 
ing distrust  among  the  business  public. 

Perhaps  some  light  can  be  thrown  upon  the  perplexing 
question  as  to  the  amount  of  cash  which  the  reserve  city 
banks  would  release  by  considering  the  present  situation. 
On  October  21,  1913,  these  institutions  were  keeping 
$250,506,000  in  their  vaults  (including  the  redemption  fund 
which  they  were  then  allowed  to  include),  while  they  were 
required  to  carry,  in  round  numbers,  only  $239,395,000. 
The  excess  of  $11,111,000  is  equivalent  to  .0058  per  cent  on 
the  total  deposits  subject  to  reserve  requirements  at  that 
time. 

If,  at  the  beginning  of  the  twenty-fifth  month,  thej' 
should  hold  a  sum  equivalent  to  .0058  per  cent  of  their 
deposits  in  excess  of  the  legal  minimum  which,  under  the 
law,  at  that  time  they  must  hold  in  cash  in  their  o^mi  vaults, 
the  amount  which  would  be  thereby  required  as  the  addi- 
tional vault  surplus  reserve  would  be  as  follows: 


RESERVES  IN  RESERVE  CITIES  279 

(1)  Where  the  country  banks  finance 
themselves  as  far  as  possible  from  their 
own  vaults,  calling  upon  the  reserve  city 
and  central  reserve  city  banks,  respec- 
tively, in  equal  amounts  for  such  with- 
drawals a.s  are  necessary  to  finance  the 
balance  of  their  payments  to  the  Federal 

reserve  banks  $10,823,183.96 

(2)  Where  the  country  banks  finance 
one-half  of  their  payments  to  the  Federal 
reserve  banks  out  of  the  surplus  cash  in 
their  own  vaults,  calling  upon  the  reserve 
city  banks  and  the  central  reserve  city 

banks  in  equal  amounts  for  the  balance.  .$10,793,089.50 

(3)  Where  the  country  banks  force 
the  entire  burden  of  furnishing  funds  to 
make  payments  to  the  Federal  reserve 
banks  upon  the  reserve  city  banks  and 
the  central  reserve  city  banks,  respec- 
tively, in  equal  amounts $10,478,248.69 

Upon  this  general  assumption  we  see,  therefore,  that  the 
reserve  city  banks,  if  they  maintain  their  present  relative 
positions,  would  decide  to  keep  a  cash  reserve  over  and 
above  the  new  legal  minimum  of  between  $10,000,000  and 
$11,000,000.  In  other  words,  it  is  very  probable  that  these 
institutions,  unlike  the  country  banks,  will  run  their  vault 
reserves  down  to  within  about  ten  million  dollars  of  the  new 
legal  limit,  and  not  force  any  larger  burden  upon  the  central 
reserve  banks  than  is  necessary.  This  might  well  be  kept  in 
mind  in  connection  with  the  discussion  which  follows  in  the 
chapter  on  the  central  reserve  cities  conceraing  the  probable 
extent  of  the  demands  which  may  be  made  upon  these  insti- 
tutions by  the  other  two  classes  of  national  banks. 

Reserve  City  Banks  in  a  Strong  Position. — Whether 
the  reserve  city  banks  will  draw  upon  their  cash  to  the 
extent  necessary  to  finance  one-half  of  their  pajnnents  to  the 
central  reserve  banks    can  not  be  definitely  foretold.     But 


280      OPERATION  OF  THE  NEW  BANK  ACT 

this  much  is  certain :  the  reserve  city  banks  can,  if  they  so 
elect,  force  the  entire  burden  of  financing  the  payments  of 
both  classes  upon  the  central  resei-ve  city  institutions,  just 
as  we  have  found  the  country  banks  could  do.  It  does  not 
require  any  calculation  to  foresee  the  tremendous  load  which 
would  thus  be  forced  upon  the  central  reserve  banks, — a 
burden  whose  real  extent,  however,  can  not  be  realized 
until  the  figures  have  been  analyzed. 

Of  course  this  does  not  mean  that  every  one  of  the 
three  hundred  and  fourteen  reserve  city  banks  is  in  a  posi- 
tion to  pass  the  burden  along  to  its  reserve  agents.  It  is 
possible  that  many  of  these  banks  are  not  in  this  particular 
as  strongly  fortified  as  the  general  average.  If  such  is  the 
case,  the  banks  with  the  smaller  proportion  of  available 
cash  or  smaller  reserve  balances  can  easily  solve  their  prob- 
lem by  rediscounting. 

Will  the  Reserve  City  Banks  Have  to  Rediscount? — 
It  should  be  emphasized  that  our  examination  of  the  opera- 
tion of  the  reserve  requirements  up  to  this  point  has  shown 
conclusively  that  it  is  not  necessary  for  the  country  banks 
and  the  reserve  city  banks,  as  a  whole,  to  rediscount  in  order 
to  make  the*  required  pajonents  to  the  Federal  reserve  banks. 
Both  have  ample  resources  without  resorting  to  this  practice. 
The  country  bankers,  as  we  have  seen,  would  probably  be 
most  willing  to  rediscount,  since  in  many  sections  of  this 
country  this  practice  is  already  followed  to  some  extent. 
The  reserve  city  banks  have,  practically  speaking,  never 
rediscounted,  and  there  has  always  been  strong  opposition 
to  the  practice  on  the  ground  that  it  was  "bad  banking." 
The  passage  of  a  law  can  not  make  over  a  banker's  mind, 
and  so  long  as  this  view  continues  it  is  not  likely  that  the 
reserve  city  institutions  will,  as  a  whole,  resort  to  the  prac- 
tice. Indeed  the  business  motive  for  rediscounting,  even 
though  there  should  be  no  sentiment  against  it,  is  entirely 
lacking.  Under  the  conditions  which  will  probably  pre- 
vail, the  reserve  city  banks,  even  up  until  the  end  of  the 
three-year  period  of  adjustment,  will  have  large  balances  on 
deposit  with  their  central  reserve  agents.    These  balances, 


RESERVES  IN  RESERVE  CITIES  281 

like  those  of  the  country  banks,  have  in  the  past  been 
attracted  by  the  interest  of  two  per  cent  per  annum  paid  by 
the  central  reserve  city  banks.  "While  this  rate  is  not  very 
attractive,  the  money,  if  kept  at  home,  would  heretofore  have 
been  absolutely  unproductive,  and  the  interest  offered  has 
been  sufficient  to  draw  large  sums  to  the  central  reserve 
cities. 

It  is  to  be  hoped  that  the  reader  has  kept  clearly  in  mind 
that,  in  the  preceding  calculations,  we  have  gone  no  further 
than  the  end  of  the  thirtieth  month  in  our  study  of  the  read- 
justment of  reserves.  No  consideration  has  been  given  to 
the  final  steps  occurring  at  the  end  of  the  third  year,  at 
which  time  the  optional  portion  of  the  reserves  of  the  reserve 
city  banks,  amounting  to  four-fifteenths  of  the  total  reserve, 
can  no  longer  be  carried  with  the  old  reserve  agents.  We 
have  presumed  throughout  that  the  optional  reserve  will  be 
carried  throughout  the  three-year  period  with  the  present 
reserve  agents.  The  effect  which  the  shifting  of  this 
optional  reserve  at  the  end  of  thirty-six  months,  either  to  the 
vaults  of  the  member  banks  or  to  the  reserve  banks,  will 
have  upon  the  banking  situation  of  the  country,  must  be 
left  for  consideration  till  a  later  chapter. 


CHAPTER  XXIV 

The  Reserve  Problem  in  New  York  and  the  other 
Central  Reserve  Cities 

The  Banking  Situation  in  New  York. — Nowhere  in  the 
world  is  there  a  banking  situation  such  as  exists  in  New 
York  City.  To  a  much  smaller  degree,  the  highly  unique 
conditions  prevailing  in  the  American  metropolis  are 
found  in  the  other  two  central  reserve  cities,  Chicago  and 
St.  Louis.  Fostered  by  a  bank  act  which  has  put  a  premium 
upon  the  concentration  of  money  in  a  few  institutions 
neither  designed  nor  especially  equipped  to  act  as  central 
banks,  and  developed  by  the  persistent  work  of  two  genera- 
tions of  exceedingly  able  men,  the  financial  situation  in 
New  York  has  reached  a  pinnacle  from  which  many  believe 
it  is  about  to  topple. 

Half  of  New  York's  Deposits  Are  Bankers'  Bal- 
ances.— New  York  is  unique  in  that  she  is  doing  business 
to  a  large  extent  on  the  deposits  of  other  banks.  The  aggre- 
gate deposits  of  her  national  banks,  as  reported  to  the 
Comptroller,  on  October  21,  1913,  were  $1,356,902,000,  of 
which  $715,646,000  consisted  of  individual  deposits  and 
$641,256,000  of  bankers'  deposits.  Of  the  bankers'  de- 
posits, $337,457,000  was  due  to  other  national  banks,  $122,- 
671,000  was  due  to  State  and  private  banks  and  bankers, 
and  $181,128,000  was  due  to  trust  companies  and  savings 
banks.  The  balance  of  the  deposits  of  the  national  banks 
was  made  up  of  United  States  deposits,  postal  savings 
deposits,  deposits  of  United  States  disbursing  officers,  etc. 
This  tremendous  total  of  deposits  is  held  by  thirty-six 
national  banks. 

The  situation  in  Chicago,  where  there  are  nine  national 
banks,  is  vers^  similar.  The  individual  deposits  in  that  city 
aggregated  $215,663,000,  while  the  bankers'  deposits,  to- 

282 


CENTRAL  RESERVE  CITIES  283 

tailing  $241,000,000,  are  made  up  of  $149,834,000  due  to 
other  national  banks,  $76,698,000  due  to  State  and  private 
banks  and  bankers,  and  $14,474,000  due  to  trust  companies 
and  savings  banks. 

In  St.  Louis,  the  seven  national  banks  have  individual 
deposits  of  $62,318,000,  and  bankers'  deposits  of  $82,962,- 
000,  composed  as  follows : 

Due  to  other   national    banks    $53,600,000 

Due  to  State  and   private   banks  and   bankers    26,207,000 

Due  to  trust  companies  and  savings  banks    3,155.000 

The  problem  of  St.  Louis  is  the  easiest  of  all  to  solve, 
because  the  liabilities  of  its  national  banks  are  very  much 
smaller  than  those  of  the  banks  in  the  other  two  cities. 
Hence  it  is  easier  to  finance  their  requirements,  whatever 
time  demonstrates  them  to  be,  because  the  proportion  which 
the  liabilities  of  these  institutions  bear  to  the  liabilities  of 
the  institutions  of  the  surrounding  cities,  which  will  prob- 
ably be  included  in  the  St.  Louis  district,  is  much  smaller 
than  in  the  case  of  New  York  City.  The  same  is  true, 
though  to  a  much  less  degree,  in  the  case  of  Chicago. 

Interest  of  Central  Reserve  Cities  in  Reserve  Pro- 
visions.— It  was  openly  charged  by  the  Secretary  of  the 
Treasury  that  the  fight  against  the  Currency  Bill  in  Con- 
gress was  fostered  and  aided  by  the  central  reserve  city 
banks,  because  of  the  tremendous  stake  which  they  had 
in  the  outcome  of  the  struggle.  Anyone  Avho  pictures  for 
a  moment  the  size  of  the  bankers'  deposits  in  the  three 
central  reserve  cities,  aggregating  over  $965,000,000,  as  con- 
trasted with  the  total  individual  deposits  of  the  three  cities, 
aggregating  $993,000,000,  can  understand  that  the  central 
reserve  city  bankers,  although  tlioy  probably  did  nothing 
unpatriotic,  felt  the  keenest  anxiety  as  to  the  form  which 
the  Federal  Reserve  Act  would  take. 

New  York  is  the  Storm  Center. — In  considering  the 
effect  of  the  partial  or  entire  withdrawal  of  bankers'  de- 
posits in  the  central  reserve  cities,  one's  interest  irresistibly 
centers  upon  New  York  City.    Possessing  the  lion's  share 


284       OPERATION  OF  THE  NEW  BANK  ACT 

of  these  deposits,  having  been  the  subject  of  searching  in- 
quiry by  Congressional  committees  and  individuals,  and 
having  been  the  persistent  object  of  banking  reform  cru- 
sades for  a  decade,  it  is  not  difficult  to  understand  the 
tremendous  interest  which  surrounds  the  question  as  to 
what  effect  the  Currency  Act  will  have  upon  that  city. 
Every  one  agrees  that  New  York's  problem  is  the  most 
serious  for  solution ;  if  it  can  be  handled,  there  need  be  no 
doubt  as  to  the  successful  readjustment  of  affairs  in  Chi- 
cago and  St.  Louis.  While  there  are  thirty-six  national 
banks  in  New  York  City,  most  of  which  by  comparison  with 
banks  in  other  cities  are  of  very  considerable  size,  yet, 
relatively  speaking.  New  York  City  is  composed  of  a  few 
very  large  banks,  and  a  number  of  much  smaller  institu- 
tions. The  very  large  banks  have  achieved  their  unusual 
size  partly  because  of  the  influence  and  ability  of  their  staffs, 
and  more  particularly  of  their  directorate,  in  attracting 
individual  deposits.  These  banks  have  also  been  persistently 
active  in  securing  bankers'  deposits. 

Widespread  Affiliations  of  New  York  Banks. — Some 
idea  of  the  tremendous  scope  of  the  affiliations  of  the  New 
York  banking  institutions  can  be  secured  from  the  follow- 
ing data  furnished  by  them  to  the  Pujo  Money  Tiiist  In- 
vestigating Committee  in  the  fall  of  1912 : 

OuT-oF-Towx  Bank  Depositors 

Bankers  Trust  Company    237 

National  Bank  of  Commerce   1,671 

Chase  National  Bank   3,103 

First   National    Bank    579 

Guaranty  Trust  Company    182 

Hanover  National  Bank    4,074 

Liberty  National    Bank    312 

Mechanics  &  Metals  National   Bank    1,010 

National  City  Bank  1,889 

National    Park    Bank    2,426 

Total     15,483 

When  we  consider  that  there  are  about  25,000  banks  in 
the  country,  and  that  these  ten  institutions  have  accounts 


CENTRAL  RESERVE  CITIES  285 

with  over  half  of  them,  we  understand  clearly  why  New 
York  is  the  center  of  financial  America,  and  why  any 
disturbance  there  works  such  widespread  havoc.  Of  the  ten 
institutions  given  above  as  having  large  banking  affiliations, 
eight  are  national  banks.  As  a  matter  of  fact,  in  discussing 
the  matter  of  bankers'  deposits,  the  custom  has  grown  up 
in  New  York  of  referring  to  the  "Big  Six,"  a  term  which 
applies  to  the  national  banks  just  named,  with  the  excep- 
tion of  the  Liberty  National  and  the  Mechanics  and  ^letals 
National  Bank.  It  should  not  be  inferred,  however,  that 
the  ten  institutions  listed  are  the  only  ones  in  New  York 
which  carr\'  bankers'  deposits. 

Bankers'  Deposits  of  Big  Nevi^  York  Nationals. — The 
exact  status  of  each  of  the  eight  national  banks,  with  re- 
gard to  the  matter  of  bankers'  deposits,  and  the  proportion 
of  such  deposits  which  they  hold  as  compared  with  the 
other  banks  of  New  York  City,  is  shown  in  the  following 
table : 

No.  of  out- 
of-town  Bankers'  de-  Individual 
bank  de-  posits  (000  deposits  (000 
positors  omitted)  omitted) 
Nov.  1,  1912.  Oct.  21.  1913.  Oct.  21.  1913 

National  Bank-  of  Commerce.  .  .  1671  $66.-562  $58,66.3 

Chase    National     310.3  75,995  38,719 

First   National    579  54,911  47,616 

Hanover    National     4074  66.342  25,539 

Liberty  National    312  14,197  12,711 

Mechanics  &  Metals  National.  .  1010  30,034  29,685 

National   Citv  Bank    1889  92.454  108,567 

National  Park  Bank   2426  61,688  39,505 

Total     15,064  $462,183  $361,005 

Total   deposits    in   all    National 

Banks  in  New  York  City..  $641,250  $715,646 

Of  the  thirty-six  national  banks  in  New  York  City,  the 
eight  institutions  listed  above  are  by  far  the  most  impor- 
tant. Their  capital  and  surplus  aggregate  sixty-seven  per 
cent  of  the  total  capital  and  surplus  of  all  of  the  national 
banks  in  the  city.  They  hold  fifty  per  cent  of  the  in- 
dividual deposits  and  seven-two  per  cent  of  the  bankers' 


286       OPERATION  OF  THE  NEW  BANK  ACT 

deposits.  The  problem,  whatever  it  may  be,  of  readjusting 
the  reserves  to  meet  the  requirements  of  the  Federal  Re- 
serve Act  will  concern  most  especially  these  eight  institu- 
tions. 

Vicious  Results  of  Paying  Interest  on  Bankers'  Bal- 
ances.— Nowhere  are  the  defects  and  limitations  of  the  old 
sj'stem  of  deposited  reserv^es  so  clear  as  in  the  case  of  New 
York  City.  We  have  already  commented  upon  the  practice 
of  the  New  York  banks  in  paying  interest  upon  bankers' 
deposits,  and  have  noted  the  vigorous  criticism  of  the  matter 
by  the  New  York  Clearing  House  Committee  following  the 
panic  of  1873.  Very  few^  bankers  will  contend  that  there 
is  any  large  amount  of  money  made  by  the  central  reserve 
city  banks  directly  from  bankers'  deposits.  They  are 
largely  the  result  of  a  consistent  campaign  to  attract  them, 
continuously  conducted  over  a  series  of  years,  and  more 
especially  they  are  held  by  the  payment  of  two  per  cent 
per  annum  interest  on  such  accounts.  When  to  the  interest 
of  two  per  cent  is  added  the  cost  of  handling  such  funds, 
variously  estimated  by  bankers  as  from  one  to  two  per  cent, 
it  win  be  seen  that  if  a  bank  hopes  to  avoid  a  loss  upon  the 
transaction,  it  must  see  to  it  that  these  funds  are,  as  nearly 
as  possible,  constantly  employed.  In  view  of  this  neces- 
sity, the  national  banks,  as  a  class,  have  for  years  kept  on 
hand  a  very  small  amount  of  cash  over  and  above  the  mini- 
mum reserve  requirement.  The  proportion  of  the  reserves 
of  the  banks  which  heretofore  have  been  of  use  to  them  in 
meeting  extraordinary  demands  consists  of  the  surplus  over 
and  above  the  legal  minimum.  When  the  reserve  of  the 
bank  runs  below  the  minimum,  the  institution  must,  under 
the  law,  cease  making  discounts  or  loans,  which,  in  sub- 
stance, means  that  the  customary  channels  of  funds  to 
finance  business  are  suddenly  dried  up. 

New  York  City  Banks  Have  Been  Central  Banks, — 
The  New  York  City  banks  have,  in  a  rough  way,  been  cen- 
tral institutions  for  many  years.  Eight  of  them  have  car- 
ried a  considerable  proportion  of  the  secondary  reserve  of 


CENTRAL  RESERVE  CITIES  287 

15,000  institutions,  just  as  the  Bank  of  England  and  the 
Bank  of  France  carry  the  secondary  reserves  of  other  insti- 
tutions. The  New  York  banks  have,  to  a  limited  degree, 
rediscounted  for  these  banks  and  made  loans  to  them.  They 
have  acted  as  media  for  the  collection  of  out-of-town 
checks,  and  for  the  paj'ment  of  intersectional  debts  through 
the  sale  by  the  country  bank  to  its  customers  of  drafts 
drawn  by  it  upon  its  accounts  in  these  institutions.  It  is 
true  that  this  comprises  only  a  part  of  the  functions  of  a 
central  bank ;  and  that,  in  many  respects,  the  central  reserve 
city  banks  have  never  possessed  the  powers  essential  to  any 
really  effective  central  institution,  such  as,  for  example, 
the  power  of  note  issue  upon  assets  other  than  govern- 
ment bonds.  But  these  lirditations,  of  which  this  is  but  an 
illustration,  would  serve  to  emphasize  the  importance  on 
the  part  of  these  institutions  of  exercising  even  greater  care 
than  would  be  necessary  with  foreign  banks,  which  could 
perhaps  afford  to  carry  lower  reserves,  because  they  could 
prevent  impairment  of  reserves  through  their  ability  to 
issue  notes  against  their  assets. 

Reserve  Policy  of  New  York  Banks. — The  reserves  of 
the  New  York  banks  on  or  about  October  1  of  each  year 
from  1883  to  1901,  inclusive,  averaged  28.8  per  cent,  and  in 
the  fall  months  from  1902  to  1912,  inclusive,  they  averaged 
26.4  per  cent.  In  the  first  period  the  reserve  was  3.8  per 
cent  above  the  legal  minimum,  while  in  the  latter  period  it 
was  only  1.4  per  cent  above  that  minimum.  If  we  compare 
these  reserves  with  those  held  by  foreign  banks,  we  can  see 
one  of  the  most  important  reasons  why  the  New  York  insti- 
tutions are  so  helpless  in  times  of  financial  stress.  We  must 
bear  in  mind  that  the  foreign  banks  are  not  required  to  keep 
any  specified  minimum  reserve  against  their  deposits,  and 
yet  they  customarily  carry  a  very  much  higher  reserve  than 
that  which  has  for  years  been  carried  by  the  central  reserve 
city  banks,  even  though  the  foreign  banks  are  in  a  much 
better  position  to  take  care  of  their  business.  The  Bank 
of  England  carries  habitually  from  forty  to  fifty  per  cent 


^ 


2^3       OPERATION  OF  THE  NEW  BANK  ACT 

reserve  against  its  demand  liabilities.  The  Imperial  Bank 
of  Germany  carries  a  reserve  in  the  neighborhood  of  seventy 
per  cent  in  gold  against  its  notes,  and  a  reserve  of  fifty  per 
cent  against  its  notes  and  deposits.  The  Bank  of  France 
carries  a  reserve  of  about  seventy-five  per  cent  of  coin 
against  notes  and  deposits. 

It  is  small  wonder,  in  view  of  the  very  much  larger  re- 
serves which  are  carried  abroad,  that  the  effectiveness  of 
the  foreign  banks  is  so  much  greater  than  that  of  our  cen- 
tral reserve  city  institutions.  The  Bank  of  England  has 
no  power,  generally  speaking,  to  issue  notes  except  against 
gold,  and  such  notes  when  issued  are  really  nothing  more 
than  warehouse  receipts.  Even  without  the  power  of  issuing 
asset  currency,  this  is  the  greatest  bank  in  the  world,  and 
has  earned  for  itself,  by  its  remarkable  performance  extend- 
ing over  generations,  the  admiration  and  confidence  of  the 
entire  world. 

Collateral  Loans  vs.  Commercial  Paper. — Unlike  the 
foreign  banks,  the  central  reserve  city  national  banks  have 
not  extensively  invested  their  funds  in  commercial  paper. 
Their  inability  to  rediscount  this  paper  or  to  issue  notes 
against  it,  which  in  effect  would  accomplish  the  same  result, 
has  forced  them  to  adopt  the  practice  of  investing  a  large 
proportion  of  their  funds  in  call  loans.  In  other  w^ords, 
they  have  followed  the  practice  of  keeping  a  cash  reserve 
very  close  to  the  minimum  specified  in  the  laAV,  relying  for 
protection  upon  their  secondary  reserve,  which  is  made  up 
largely  of  call  loans.  In  ordinary  times,  this  plan  works 
reasonably  well.  Banks  whose  reserves  fall  below  the  legal 
level  can  call  loans,  which  are  largely  repaid  by  the  bor- 
rower shifting  the  loans  to  other  banks.  But  experience 
has  demonstrated  over  and  over  again  that  in  times  of  great 
stress  or  panic,  when  the  great  majority  or  all  of  the  banks 
are  forced  to  contract,  the  call  loan  is  inconvertible.  Bor- 
rowers have  no  place  to  turn,  and  if  the  banks  should  force 
them  to  sell  their  collateral,  the  bottom  would  drop  out  of 
the  stock  market  and  the  banks  themselves  would  be  ruined 


CENTRAL  RESERVE  CITIES  289 

by  the  disappearance  of  the  value  of  the  collateral  which 
they  hold. 

Mr.  Charles  P.  Blynn,  Jr.,  President  of  the  Massachu- 
setts Bankers'  Association,  in  testifying  before  the  Senate 
Committee,  made  the  following  comment  upon  this  point. 
"The  central  reserve  banks,  being  the  custodians  of  the  re- 
serves of  the  country,  have  been  compelled  to  carry,  in  addi- 
tion to  the  twenty-five  per  cent  required  by  hiw,  a  reserve 
of  thirty-five  or  thirty  per  cent  more.  They  (the  central 
reserve  banks)  carry  loans  which  are  quickly  convertible 
and  that  is  why  we  have  grown  into  making  stock  exchange 
loans.  There  is  a  preconceived  idea  that  New  York  banks 
loan  on  stock  exchange  collateral  because  the  management 
of  the  banks  are  interested  in  the  stock  exchange.  They 
loan  on  stock  exchange  collateral  because  that  offers  them 
the  best  form  of  reserves." 

Relations  of  New  York  Banks  with  Stock  Exchange 
Operations. — Entirely  too  much  emphasis  has  been  placed 
by  many  critics  of  the  New  York  situation  upon  the  motives 
of  the  New  York  bankers,  and  upon  the  great  prominence 
which  stock  exchange  operations  play  in  their  affairs.  There 
is  no  doubt  that  the  very  close  connection  between  the  loans 
of  the  New  York  City  banks  and  speculation  on  the  stock 
exchange  has  been  harmful  to  the  country  at  large  and  to 
the  New  York  banks  themselves ;  but  to  assert  that  the  New 
York  banks  have  voluntarily  created  this  condition,  because 
of  some  improper  interest  in  the  operations  of  the  Ex- 
change, or  to  give  the  impression  that  loans  by  the  New 
York  banks,  particularly  by  those  holding  bankers'  de- 
posits, are  almost  entirely  upon  stock  exchange  collateral, 
would  be  very  inisleading. 

Distribution  of  Loans  of  New  York  Banks. — Mr.  Alex- 
ander Gilbert,  President  of  the  IMarket  and  Pulton  National 
Bank  of  New  York  City,  submitted  the  following  figures 
which  he  had  procured,  and  which  show  in  detail,  better 
than  anything  else,  the  character  of  the  loans  made  by  the 
large  financial  institutions  of  New  York  City : 
19 


^^00       OPERATION  OF  THE  NEW  BANK  ACT 

Distribution  of  loans  and  discounts  made  by  'M  of  tlie  largest 
banks  and  trust  companies  in  New  York  City,  each  having  approxi- 
mately $20,000,000  or  more  of  loans  and  discounts,  and  aggregate 
loans  and  discounts  of  $1,226,974,500,  at  close  of  business  September 
24,  1913. 
First,  loans  made  to  Wall  Street  brokers  for  banks 

outside  of  the  city  of  New   York $174,945,900 


Second,  loans  made  to  Wall  Street  brokers  for  banks' 

own   account    $264,383,800 

Third,  otiier  loans,  discounts,  and  advances  of  every 
nature   distributed  geographically   as  below: 

Total  Eastern  States :  Northeastern  States — Maine, 
New  Hampshire,  Vermont,  Massachusetts,  Rhode 
Island,  and  Connecticut;  Eastern  States — New 
York  State,  Pennsylvania,  New  Jersey,  Llary- 
land.  District  of  Columbia,  and  Delaware 617,830,800 

Total  Southern  States:  Southern  States — Virginia, 
West  Virginia,  North  Carolina,  South  Carolina, 
Georgia,  Florida,  Alabama,  Mississippi,  Louisiana, 
Kentucky,    Tennessee,    Texas,   and    Arkansas....         174,140,500 

Total  Western  States:  Middle  W'estern  States — Ohio, 
Indiana,  Illinois,  Michigan,  Wisconsin,  Minnesota, 
Iowa,  and  Missouri;  Western  States — North 
Dakota,  South  Dakota,  Nebraska,  Kansas,  Mon- 
tana, Wyoming,  Colorado,  Oklahoma,  and  New 
•  Mexico;  Pacific  States — Washington,  Oregon, 
California,  Idaho,  Utah,  Nevada,  and  Arizona..         167,720.000 

Foreign :    Canada,   etc 2,898,800 


Total  banks'  own  loans    $1,226,974,500 

Direct  Lending  by  Out-of-town  Banks. — The  first  item 
in  this  table  desers^es  a  brief  explanation.  Of  late  years, 
largely  as  a  result  of  the  competition  between  the  State  banks 
and  trust  companies,  the  practice  has  grown  up  of  country 
banks  lending  money  directly  on  the  market,  at  times  when 
the  call  loan  interest  rates  are  attractive,  the  New  York 
banks  acting  as  their  agents  in  making  the  loans.  Thus  the 
country  banks  have  a  double  relation  to  the  stock  market 
in  New  York :  ( 1 )  the  more  indirect  one  in  which  the  funds 
which  they  have  deposited  with  the  New  York  banks  are 
loaned,  in  whole  or  in  part,  by  the  latter  as  though  they  were 
local  deposits,  direct  upon  the  market;  and  (2)  the 
direct  one  in  which  the  country  bank,  through  the  New 
York  bank  as  agent,  will  lend  in  its  ovm  name  any  surplus 


CENTRAL  RESERVE  CITIES  291 

funds  which  it  may  have  on  deposit  with  the  New  York 
bank.  This  practice  adds  considerably  at  times  to  the 
profits  of  the  country  banks  upon  their  New  York  balances, 
or  upon  that  proportion  of  their  balances  over  and  above 
the  legal  reserve  which  they  must  keep,  in  order,  when 
added  to  their  cash  holdings,  to  equal  the  required  fifteen 
per  cent. 

However,  when  the  country  bank  is  crowded  for  money 
it  will  call  its  direct  loans.  When  these  are  paid,  the  money 
is  credited  to  the  account  of  the  eouutiy  bank  upon  the 
books  of  its  New  York  correspondent,  thereby  raising  its 
reserve  by  this  amount,  and  accomplishing  the  purpose 
which  prompted  the  calling  of  the  loan.  If  the  country 
bank  so  desires,  it  can  telegraph  its  New  York  correspondent 
to  ship  cash,  charging  the  shipment  against  its  newly  re- 
plenished balance.  So  far  as  the  New  York  banks  are  con- 
cerned, it  is,  in  effect,  like  transferring  money  from  one 
pocket  to  another,  for  the  cash  with  which  the  New  York 
borrower  repays  the  direct  loan  of  the  country  bank  must, 
to  a  large  degree,  be  procured  by  negotiating  another  loan 
with  a  New  York  City  bank.  Tlius,  in  so  far  as  the  total 
supply  of  money  in  New  York  City  is  concerned,  the  direct 
loans  are,  in  times  of  stress,  a  source  of  great  worry  and 
danger. 

Proportion  of  Loans  to  Brokers. — According  to  IMr. 
Gilbert's  calculations,  the  New  Yoi-k  City  banks  themselves, 
for  their  own  account,  had  loaned  the  Wall  Street  brokers, 
on  September  24  last,  only  $264,000,000  out  of  total  loans 
made  by  them  of  some  $1,226,000,000,  or  about  twenty-ono 
per  cent  of  the  total.  Tlie  majority  of  loans,  he  claims,  are 
made  to  individuals,  firms  and  corporations  outside  of 
New  York  City,  over  half  of  the  total  loans  being  in  the 
eastern  States.  Mr.  Crilbort  asserts  that  seven-eighths  of 
these  loans  are  made  upon  commercial  paper  aiul  securities. 
His  tabulation  is  doubtless  correct  in  the  main,  but  there 
is  a  sufficient  difference  between  the  impressions  which  one 
would  get  from  his  calculation  and  that  which  arises  if  wp 
examine  the  figures  at  as  late  a  date  as  possible  for  indi- 


292       OPERATION  OF  THE  NEW  BANK  ACT 

vidual  banks,  to  warrant  the  insertion  of  the  following 
comparison,  based  upon  the  investigations  of  the  account- 
ants of  the  Money  Trust  Investigation  Committee.  This 
shows  the  total  deposits  of  the  out-of-town  banking  cor- 
respondents with  the  eight  national  banks  mentioned  therein, 
the  direct  loans  which  these  banks  had  made  for  these  cor- 
respondents upon  stock  exchange  collateral,  and  the  loans 
of  each  New  York  City  bank,  upon  time  or  demand,  on 
such  collateral  on  November  1,  1912: 

(000  omitted) 

Deposits          Direct  loans  Bank's 

by                       for  own 

correspondent,  correspondent.  loans. 

National    Bank    of    Commerce...  $42,909  $18,080  $38,230 

Chase    National    70,007  57,990  34,915 

First  National 40.127  43,454  42.275 

Hanover   National    47,145  5,414  11,045 

Liberty   National    7,414  1,810  11,543 

Mechanics   &   Metals    National...  17,910  4.220  13,502 

National  City    75,172  10,200  84,788 

National    Park    49,058  14,808  37,375 

Total     $349,742         $155,976        $273,673 

Country  Money  and  the  Stock  Exchange. — The  tre- 
mendous amount  of  country  money  w^hich  is  loaned  out  on 
stock  exchange  collateral  is  clearly  seen  from  the  above 
comparison.  The  country  banks  have  on  deposit  with  their 
correspondents  approximately  $350,000,000,  while  in  addi- 
tion they  have  loaned  on  stock  exchange  collateral  $155,- 
000,000,  making  a  total  in  excess  of  $500,000,000  in  New 
York  City  at  that  time.  Of  the  deposits  of  the  out-of-town 
correspondents  with  New  York,  $273,000,000,  or  almost 
eighty  per  cent  of  the  total,  have  been  similarly  loaned. 
This  exceeds  somewhat  the  amount  of  such  deposits  which 
the  New  York  banks  can  loan  and  still  keep  the  required 
twenty-five  per  cent  resen^e  against  them.  Accuracy,  how- 
ever, demands  that  it  should  be  noted  that  bank  loans  on 
stock  exchange  collateral  are  not  to  be  viewed  entirely  with 
relation  to  out-of-town  deposits,  since,  as  we  have  seen, 
the  banks  have  very  large  resources  aside  from  these 
deposits. 


CENTRAL  RESERVE  CITIES  293 

Partiality  to  Collateral  Loans. — Al'tei'  all,  the  main 
thing  for  our  purposes  is  not  whether  the  New  York  banks 
have  been  unduly  wedded  to  stock  exchange  loans,  whether 
they  have  stimulated  stock  exchange  operations  by  pursuing 
to  an  extreme  degree  the  policy  of  call  loans,  or  whether 
it  is  a  good  or  bad  thing  for  the  country  to  have  the  present 
situation  as  it  exists  in  New  York.  The  most  important 
lesson  of  the  New  York  situation  is  not  to  be  learned  from 
the  degree  of  intimacy  of  the  banks  with  the  stock  exchange, 
but  the  extent  to  which  their  resources  are  tied  up  in  loans 
upon  collateral  rather  than  investments  in  commercial 
paper.  The  exact  situation  is  to  be  seen  from  the  following 
compilation  of  the  Comptroller  of  the  Currency,  as  of  June 
14,  1912,  showing  how  the  loans  of  the  national  banks  of 
New  York  City  were  made  up : 

On   demand,   paper   with   one   or   more   individual   or   firm 

names      *  $17,790 

On  demand,  secured  by   stocks,  bonds,  and  other  personal 

security    320,897 

On    time,    paper    witli    two    or    more    individual    or    firm 

names    171,791 

On  time,  single  name  paper   (one  person  or  firm)   witliout 

other  security   219.172 

On    time,    secured    by    stocks,    bonds,    or    other    personal 

security,  or  on  mortgages  or  otiier  real  estate  security.  .     223,410 

*000  omitted.  $959,008 

New  York  Banks  Largely  Commercial  Banks. — Of 
late  the  New  York  banks  have  awakened  to  the  importance 
of  the  fact  that  they  are  great  investors  in  commercial  paper. 
The  National  City  Bank,  the  largest  bank  in  New  York 
City,  and,  in  fact,  in  the  United  States,  in  its  monthly 
circular  for  December,  1913,  emphasizes  the  importance  of 
commercial  loans  in  its  business,  and  appends  the  follow- 
ing classification  of  loans,  showing  in  the  first  column,  as 
of  December  6,  1912,  the  results  which  it  reported  to  the 
Money  Trust  Investigating  Committee,  and  in  the  second 
column,  as  of  November  25,  1913,  the  loans  as  then  out- 
standing: 


294.      OPERATION  OF  THE  NEW  BANK  ACT 

Dec.  6.  1912.  Nov.  25,  1913. 

Amount  of  loans  to  merchants  and 
manufacturers,  not  secured  by 
collateral     $39,140,509.18         $59,240,371.02 

Amount  of  loans  to  depositors  and 
others,  not  members  of  the 
Stock  Exchange,  on  collateral       44,150,658,50  41,100,743.00 

Amount  of  demand  loans  to  mem- 
bers of  the  Stock  Exchange  on 
stock  exchange  collateral   27,681,320.01  28,591,000.00 

Amount  of  time  loans  to  mem- 
bers of  the  Stock  Exchange  on 
stock  exchange  collateral 1,475,000.00  735,000.00 

Amount  of  loans  and  re-dis- 
counts to  interior  banks  and 
trust  companies  on  collateral 
(mostly  bills   receivable)     ...  7,869,000.00  14,180,106.25 

Amount  of  unsecured  loans 1,599,404.00 

Amount  of  loans  on  merchandise.  798,866.00  965,777.95 

Total  net  deposits   150,789,555.00         175,843,367.00 

Excluding  Stock  Exchange  Demand  and  Time  Loans,  the  loans 
of  November  '25  are  distributed  as  follows: 

Eastern  States :              To  banks     $1,358,000 

To  others    61,321,777 

New  England  States :  To  banks     10,000 

To  others     3,643,000 

Middle  States :                To  banks     2,606,000 

To  others     21,841,000 

Western  States :            To  banks     760,000 

To  others     728,000 

Pacific  States :               To  banks     767,000 

To  others    1,662,000 

Southern  States:           To  banks     11,300,000 

To  others     8,719,000 

Foreign :     1,930,000 

The  most  important  class  of  loans  of  this  great  bank, 
which  may  be  taken  as  generally  typical  of  all  the  banks  of 
New  York,  is  seen  to  be  the  loans  to  merchants  and  manu- 
facturers not  secured  by  collateral ;  while  the  loans  on 
stock  exchange  collateral,  which  were  made  to  depositors 
and  others  not  members  of  the  stock  exchange,  follow  next 
in  importance,  the  two  aggregating  over  sixty  per  cent  of 
the  total  loans  of  this  institution.  As  a  matter  of  fact,  the 
loans  to  members  of  the  stock  exchange  amount  only  to 
$29,326,000,  or  approximately  twenty  per  cent  of  the  total 
loans  of  the  bank.  When  we  consider  the  fact  that  good 
banking  has,  up  until  the  present  time,  required  the  keep- 


CENTRAL  RESERVE  CITIES  295 

ing  by  an  institution  of  this  character  of  a  secondary  re- 
serve of  demand  loans,  we  can  readily  see  that  this  bank, 
popularly  supposed  to  be  one  of  the  shining  examples  of  a 
stock  exchange  institution,  is,  after  all,  a  great  commercial 
bank  in  so  far  as  the  character  of  its  borrowers  is  concerned. 
These  facts  are  presented  here  at  length  for  the  purpose  of 
showing  the  very  great  importance  to  the  commercial  in- 
terests of  the  country  of  the  satisfactory  readjustment  of 
the  reserve  problem  of  the  central  reserve  cities.  The  banks 
of  these  cities,  as  a  whole,  are  playing  a  vital  and  most 
important  part  in  the  commercial  lending  of  this  country, 
and  if  they  are  seriously  embarrassed  or  crippled  in  their 
commercial  business  by  the  change  which  is  impending, 
then  the  reserve  provisions  of  the  Federal  Reserve  Act  are 
unwise  and  dangerous. 

The  Problem  before  the  Large  Borrower. — The  prob- 
lem is  essentially  one  of  the  large  borrower  who  has  built 
up  a  market  for  his  paper  with  the  very  large  banks  in  New 
York  City.  Heretofore,  such  borrowers, — dealing  either 
directly  with  the  banks  in  the  central  reserve  cities  or 
through  the  note  brokers, — have  placed  their  paper  with 
these  institutions.  If  this  money,  a  large  part  of  which  is 
composed  of  the  reserves  of  other  cities,  is  to  be  vrith- 
drawp  and  put  into  the  Federal  reserve  banks,  which  can 
only  place  the  money  at  the  disposal  of  business  by  redis- 
counting  such  paper  as  may  be  offered  to  it  by  member 
banks,  what  effect  will  this  have  upon  business?  The  most 
serious  question,  in  many  ways,  connected  with  this  matter 
of  reserves,  was  asked  by  ^Mr.  George  ^l.  Reynolds  in  his 
examination  before  the  Senate  Committee : 

"Mr.  Reynolds:  Would  it  be  practical  for  some  large 
concern  that  needs  to  borrow  $40,000,000,  or  $50,000,000, 
to  write  to  a  thousand  banks  in  the  Dakotas  and  sec  how 
much  of  surplus  money  in  the  Dakotas  they  could  borrow? 

"Senator  Crawford:  Of  course  not.  The  question  is 
this 

"Mr.  Reynolds:  I  am  only  putting  it  to  you  as  a  matter 
to  think  over.    I  want  to  get  it  into  the  record,  and  T  want 


296      OrERATlON  OF  THE  NEW  BANK  ACT 

you  to  give  careful  consideration  to  it.  In  our  city  and  all 
over  this  country  there  are  industrial  enterprises  that  have 
been  assisted  in  their  development  and  growth  very  largely 
by  the  dependence  on  these  lines  of  credit  received  through 
the  larger  banks  throughout  the  country,  and  if  we  are  left 
in  such  a  condition  that  we  must  discontinue  that,  then  it 
is  a  matter  for  you  to  decide  how  best  to  solve  the  problem 
so  that  they  can  go  ahead  with  their  business.  I  know  you 
want  to  solve  it  for  them.  I  am  only  bringing  this  point 
up  as  one  that  I  have  not  seen  any  solution  for  in  the  bill. 
I  have  no  doubt  but  it  can  be  worked  out. 

^'Senator  Hitchcock:  Do  you  mean  to  take  the  position, 
Mr.  Reynolds,  that  this  would  be  a  permanent  embarrass- 
ment to  the  banks  and  to  the  borrowers,  or  only  a  temporary 
embarrassment  while  the  new  system  is  being  put  into 
operation  ? 

^^3ir.  Reynolds:  I  did  not  describe  it  by  the  words  'per- 
manent embarrassment.'  I  hope  you  will  not  get  it  in  the 
record  as  putting  me  quite  in  that  light.  It  will  be  no 
embarrassment  to  the  banks,  because  the  banks  will  very 
quickly  adjust  themselves  to  changed  conditions,  if  they  are 
a  party  to  this  plan.  Then  the  public  itself  will  have  to 
adjust  itself  to  the  new  conditions.  If  those  people  who 
have  had  to  borrow  $50,000,000  under  the  new  order  of 
things  are  only  able  to  borrow  a  part  of  that  amount,  they 
will  have  to  restrict  their  business.  If  that  is  best,  that 
will  be  satisfactory  to  me.  But,  as  I  say,  it  is  a  matter  that 
will  have  to  work  itself  out,  and  it  gets  back  to  the  public, 
as  I  have  said  two  or  three  times  before.  Whatever  you  do, 
the  bankers  are  going  to  be  all  right,  because  they  are  going 
to  adjust  their  affairs  to  conditions,  but  I  hope  general 
business  will  be  protected." 


CHAPTER  XXV 

The  Shifting  of  Reserves  in  the  Central  Reserve  Cities 

Tremendous  Burden  on  Central  Reserve  Cities. — What 
will  be  the  extent  to  which  the  present  balances  in  the  cen- 
tral reserve  city  banks  "will  be  reduced  as  a  result  of  the 
new  reserve  requirements,  and  how  w'ill  this  shifting  of 
reserves  affect  these  banks  and  the  communities  which  they 
serve?  This  is  one  of  the  most  absorbing  questions  con- 
nected with  the  whole  matter  of  the  probable  operations  of 
the  Federal  Reserve  Act.  We  have  traced  at  length  the 
requirements  which  must  be  met  by  the  country  banks  and 
the  reserve  city  banks  and  have  determined,  as  far  as  pos- 
sible, the  w^ays  in  which  these  two  classes  of  institutions 
can  finance  their  needs,  and  the  probable  extent  of  their 
withdrawals  from  the  central  reserve  institutions.  How  w'ill 
these  tremendous  demands — for  they  aggregate  a  staggering 
total  even  under  the  most  favorable  assumption — affect  the 
central  reservoirs  of  our  national  banking  system  in  New 
York,  Chicago  and  St.  Louis  ?  In  order  to  answer  this  ques- 
tion, it  is  necessary  to  sum  up  the  results  secured  in  our 
preceding  inquiries  under  each  of  the  several  assumptions, 
one  of  which  time  may  show  to  accord  with  actual  conditions. 

New  Reserve  Requirements. — Before  doing  so,  how- 
ever, let  us  note  the  changes  in  the  reserve  requirements  for 
banks  in  the  central  reserve  cities  under  the  new  Act.  Here- 
tofore these  banks  have  been  required  to  keep  as  a  minimum 
a  twenty-five  per  cent  reserve.  The  Federal  Reserve  Act 
specifies  that,  "a  bank  in  a  central  resei've  city,  as  now 
or  hereafter  defined,  shall  hold  and  maintain  a  reserve  equal 
to  eighteen  per  centum  of  the  aggregate  amount  of  its 
demand  deposits  and  five  per  centum  of  its  time  deposits, 
as  follows : 

* '  In  its  vaults  six-eighteenths  thereof. 

''In  the  Federal  reserve  bank  seven-eighteenths. 

297 


298       OPERATION  OF  THE  NEW  BANK  ACT 

"The  balance  of  said  reserves  shall  be  held  in  its  own 
vaults  or  in  the  Federal  reserve  bank  at  its  option. 

"Any  Federal  reserve  bank  may  receive  from  the  mem- 
ber banks  as  reserves,  not  exceeding-  one-half  of  each  install- 
ment, eligible  paper  as  described  in  Section  14  properly 
indorsed  and  acceptable  to  the  said  reserve  bank." 

Perhaps  the  following  summary  may  be  of  assistance  to 
the  reader: 

Amount  required  to  be  kept  in  the  bank's  vault G/18 

Minimum  balance  on  deposit  with  the  Federal  reserve  bank 7/18 

Optional  balance  which  may  be  divided  between  bank's  vault  and 

the  reserve  bank   5/18 

Various  Possibilities  Concerning  Extent  of  With- 
drawals.— In  order  to  get  the  problem  as  it  affects  the 
central  reserve  city  banks  clearly  in  mind,  the  assumptions 
on  page  299,  based  upon  the  results  of  our  previous  calcu- 
lations, are  inserted.  The  letter  "  C,"  standing  before 
the  figures  in  either  column,  refers  to  the  withdrawals  of 
the  country  banks  under  this  particular  assumption,  while 
the  letter  "R"  refers  to  the  withdrawals  of  the  reserve 
city  banks. 

It  is  not  intended  in  any  w^ay  to  convey  the  impression 
that  these  five  assumptions  cover  every  possible  contingency 
which  may  arise.  There  are  a  number  of  courses  which 
would  be  open  to  the  country  banks  and  the  reserve  city 
banks,  representing  intermediate  stages  between  the  several 
steps  included  in  these  assumptions.  If  one  of  these 
intermediate  courses  was  followed  the  total  withdrawals 
would  be  between  some  two  of  the  amounts  specified.  To 
endeavor  to  cover  every  contingency  would  require  an  enor- 
mous amount  of  calculating,  which  would  not  clarify  the 
issue,  unless  one  could  foresee  exactly  the  course  which 
events  would  take.  The  five  assumptions  given  are  included 
for  the  purpose  of  showing,  in  a  very  general  way,  the 
problem  as  it  will  unfold  to  the  central  reserve  city  banks. 
The  conclusions  developed  on  one  of  these  assumptions  may 
happen  to  accord  with  what  will  occur,  but  it  is  probable 


SHIFTING  OF  RESERVES 


299 


Note.— In  each  of  the  following,  the  present  deposits  with  reserve  agents 
are  presumed  to  remain  intact,  except  as  modified  by  specific  statements.  Federal 
reserve  bank  deposits  are  always  at  the  minimum  specified  by  law.  In  every  case, 
the  withdrawals  of  country  banks  are  presumably  equally  divided  between  the 
reserve  cities  and  the  central  reserve  cities. 

ASSUMPTIONS 


Assumption  No.  1: 

Where  the  country  banks  and  reserve  city 
banks  as  a  class  supply  their  contributions 
to  the  Federal  reserve  banks  from  their  ex- 
cess cash  in  their  own  vaults  so  far  as  possible 


Assumption  No.  2: 

Where  country  banks  furnish  one-half  of 
the  contribution  to  the  reserve  banks,  with- 
drawing the  balance  from  the  reserve  city 
and  central  reserve  city  banks  in  equal  pro- 
portions, and  where  the  reserve  city  banks 
finance  their  own  requirements  as  well  as 
the  withdrawals  of  country  banks  from  their  ' 
excess  cash  holdings,  over  the  required  re-  ' 
serve,  in  so  far  as  possible C-  $.31,703,930.37 


Withdrawals  from 

central  reserve 
city  banks  by  the 
end  of  first  year. 


Aggregate  with- 
drawals from 
central  reserve 
city  banks  by 
end  of  30  months. 


C-  $49,094,195.99 
I R-     67,639,408.22 


Probably  nothing  '      $116,733,604  21 


C-  $54,282,897.77 
R-     72,205,465.79 

$126,488,363.56 


Assumption  No.  3: 

Where  the  country  banks  withdraw  their 
entire  contributions  from  the  reserve  city 
and  central  reserve  city  banks  in  equal  pro- 
portions respectively,  the  reserve  city  banks 
financing  their  own  contributions  and  with-  C-  $63,407,860.75  1  C-$108,565,795.55 
drawals  of  country  banks,  as  far  as  possible,  R-  27,620,643.42  R-  119,974,415.84 
from_  their  excess  cash  holdings,  over  the 
required  reserve 


$91,028,504.17 


C-  $31,703,930.37 
iR-     66,977.508.89 


Assumption  No.  4: 

Where  the  country  banks  and  the  reserve 
city  banks  as  a  class  each  supply  from  their 
cash  holdings  one-half  their  payments  to 
reserve  banks  withdrawing  the  balance  as 
follows:  (a)  in  the  case  of  the  country  banks 
one-half  from  the  reserve  banks  and  one-half 
from  the  central  reserve  city  banks,  respec- 
tively, (b)  in  the  case  of  the  reserve  city 
banks  the  entire  withdrawal,  namely,  one- 
half  of  their  contribution,  of  necessity  must 
be  from  their  central  reserve  agents 

Assumption  No.  5: 

Where  the  country  banks  and  the  reserve 
city  banks  each,  as  a  class,  insist  on  main- 
taining   their    present    cash    holdings,    the  , 
country  banks  drawing  their  payments  in  1 
equal  proportions  from  the  reserve  and  cen-  ! 
tral  reserve  agents  respectively,   while  the  '. 
reserve   city   banks   withdraw   their  entire   C-  $63,407,860.75 
contributions  from  the  central  reserve  city   R-  164,707,830.23 
banks  up  to  the  amount  of  their  reserve 


$228,540,211.39 


C-  $54,282,897.77 
R-  104.372.577.42 


$98,681,439.26        $158,655,475.19 


C-$108,565.795.55 
R-  257,833,661.11* 

balances'if  necessary i...  ..I      $228,115,690.98  I      $366,399,456.66 


*  To  carry  out  this  assumption,  the  reserve  city  banks  should  withdraw 
$259,771,078.74,  hut  inasmuch  as  their  balance  is  only  $257,833,661.11,  we  must 
confine   the  withdrawals  to  the  latter  figure. 


300       OPERATION  OF  THE  NEW  BANK  ACT 

that  none  will  be  exactly  correct,  and  that  between  some 
two  of  them  will  lie  the  final  result. 

Difficulty  of  an  Exact  Estimate. — However,  if  we  look 
at  the  matter  from  the  stand-point  of  the  best  and  the 
worst  that  can  happen  to  the  New  York  banks,  it  seems  prac- 
tically certain  that  the  above  assumptions  will  serve  as  a 
basis  for  our  conclusions.  The  first  is  the  most  favorable 
turn  which  affairs  could  take  for  the  New  York  banks,  while 
the  fifth  is  the  most  unfavorable  for  them.  All  assume  that 
the  surplus  balances,  whatever  they  may  be,  of  the  country 
banks  and  of  the  reserve  city  banks,  which  they  will  not  need 
in  meeting  their  payments  to  the  Federal  reserve  banks, 
will  be  left  on  deposit  with  their  present  reserve  agents  in 
the  central  reserve  cities.  Of  course,  if  the  country  banks 
and  reserve  city  banks  should  follow  the  policy  of  entirely 
withdrawing  their  present  deposits  in  New  York  City,  the 
situation  would  be  worse  than  even  the  fifth  assumption. 
However,  the  reader,  if  he  cares  to  do  so,  can  easily  work 
out  from  the  information  contained  in  the  preceding  chap- 
ters the  extent  to  which  the  load  on  the  central  reserve  city 
banks  would  be  increased.  This  contingency  is  so  unlikely 
to  occur  at  this  stage,  however,  that  it  is  not  worth  while 
to  present  the  results  in  detail.  As  w^e  have  seen,  the  coun- 
try banks  and  the  reserve  city  banks  will  for  a  considerable 
period  keep  their  balances  in  New  Yoi-k  City  because  they 
bring  them  positive  business  advantages. 

Withdrawals  During  the  First  Year. — Upon  the  basis 
of  the  above  assumptions  let  us  work  out  the  trend  which 
affairs  will  take  for  the  central  reserve  citj^  banks.  The  table 
on  page  301,  calculated  by  the  same  method  used  in  our 
investigations  of  the  country  banks  and  reserve  city  banks, 
shows  in  detail  the  effect  of  each  assumption  upon  the  central 
reserve  city  institutions  during  the  first  twelve  months. 

Ability  of  Banks  to  Handle  these  Withdrawals. — It 
has  been  assumed  throughout  this  calculation  that  cen- 
tral reserve  city  institutions  would  make  their  pa^^nents 
to  the  Federal  reser\'-e  banks  in  cash,  in  so  far  as  possible. 
This  assumption  has  been  followed  in  the  case  of  the  two 


SHIFTING  OF  RESERVES 


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302       OrERATlOxN  OF  THE  NEW  BANK  ACT 

preceding  groups  of  bauks.  The  purpose  of  this  method 
is  to  ascertain  the  size  of  the  resulting  deficit,  which  will 
determine  the  extent  to  which  rediscounting  must  be  done. 
Under  the  first  assumption,  which  is  the  most  favorable  to 
the  central  reserve  city  banks,  we  find  that  they  would  not  be 
required  to  do  any  rediscounting  during  the  first  year,  but 
would  have  a  surplus  of  over  $79,000,000,  after  meeting  the 
withdrawals  of  the  other  classes  of  banks. 

In  the  second  assumption,  under  which  the  countiy  banks 
withdraw  one-quarter  of  their  payments  from  the  central 
reserve  city  institutions  and  the  reserve  city  institutions 
finance  their  requirements,  from  their  own  vaults,  the  cen- 
tral reserve  city  institutions  would  still  not  have  to  redis- 
count, having  at  the  end  of  the  first  year  over  $53,000,000 
of  surplus  cash. 

In  the  third  assumption,  under  which  the  country  banks 
withdraw  their  entire  contributions  from  their  reserve 
agents,  taking  half  thereof  from  the  central  reserve  city 
banks,  and  where  the  resei'\'e  city  banks  finance  themselves, 
as  far  as  possible,  from  their  own  vaults,  the  central  reserve 
institutions  would  still  be  able  to  handle  the  situation  during 
the  first  year  from  their  own  cash  holdings,  the  surplus 
having  been  reduced,  however,  to  something  over  $4,000,000. 

When  we  come  to  our  fourth  assumption,  where  the 
country  banks  withdraw  one-half  of  their  pajTnents  from 
the  central  reserve  city  institutions  and  the  reserve  city 
banks  in  equal  proportions,  making  up  the  balance  of  their 
paATnents  to  the  Federal  reserve  bank  from  the  surplus  cash 
in  their  vaults,  while  the  reserve  city  banks  withdraw  one- 
half  of  their  contributions  from  their  central  reserve  agents, 
we  find  that  we  have  taxed  the  central  reserve  city  institu- 
tions to  their  limit.  As  a  matter  of  fact  they  would  have 
a  deficit  of  almost  $2,000,000.  This  could  be  handled,  of 
course,  by  ver^^  small  rediscounts.  These  rediscounts  could 
be  made  either  as  a  part  of  the  paATnents  to  the  Federal 
reser\'e  bank  on  account  of  reserves  required  to  be  deposited 
with  them,  or  they  could  be  made  by  independent  redis- 
counts, without  reference  to  any  readjustment  of  reserves. 


SHIFTING  OF  RESERVES  303 

No  Difficulty  During  First  Year. — Putting  the  matter 
in  the  woi-st  light  for  the  central  reserve  city  banks  (save 
that  the  other  classes  of  national  banks  will  withdraw  more 
than  is  necessary  to  meet  their  payments  to  the  Federal  re- 
serve banks),  we  find  that  under  our  fifth  assumption  where 
the  country  banks  and  the  reserve  city  banks  each,  as  a  class, 
insist  on  maintaining  their  present  cash  holdings,  the  coun- 
try banks  drawing  their  payments  in  equal  proportions  from 
the  reserve  and  central  reserve  agents  respectively,  while  the 
reserve  city  banks  withdraw  their  entire  contributions  from 
the  central  reserve  city  banks  up  to  the  amount  of  their 
reserve  balances,  if  necessary,  the  central  reserve  city  institu- 
tions would  have  to  rediscount  to  the  extent  of  $108,000,000 
during  the  first  twelve  months.  The  central  reserve  city 
banks  will  be  required  to  make  payments  to  the  Federal 
reserve  banks  of  something  over  $91,000,000,  representing 
the  required  reserve  which  must  be  kept  with  them ; 
$65,000,000,  constituting  the  optional  reserve,  may  be 
kept  in  cash  in  their  vaults  or  on  deposit  with  the  reserve 
banks,  in  whole  or  in  part.  Under  circumstances  where 
heavy  rediscouuting  is  necessary,  it  would  be  advantageous 
for  the  central  reserve  city  banks  to  keep  the  optional  reserve 
with  the  reserve  banks,  because  one-half  of  it  can  be  created 
on  the  books  of  the  reserve  banks  by  rediscounting  commer- 
cial paper.  If  this  view  is  correct,  the  total  reserve  pay- 
ments to  the  Federal  reserve  institutions  would  probably 
amount  to  $156,000,000,  against  which  it  would  be  necessary 
to  rediscount  to  the  extent  of  $108,000,000.  If  the  central 
reserve  city  banks  endeavored  to  meet  this  problem  by  redis- 
counting to  meet  their  reserve  requirements,  they  would  find 
themselves  unable  to  handle  the  situation.  With  total  pay- 
ments of  $156,000,000  to  the  Federal  reserve  banks  they 
would  be  allowed  (under  the  provisions  of  the  Act  pennit- 
ting  them  to  make  one-half  of  their  reserve  payments 
through  rediscounting)  to  rediscount  only  $78,000,000  of 
paper.  This  would  leave  a  deficit  of  $80,000,000  still  to  be 
provided  for.  A  liberal  interpretation  of  the  Act  would 
enal)le  the  central  reserve  oitv  institutions  to  rediscount  at 


304       OPERATION  OF  THE  NEW  BANK  ACT 

least  this  much  paper,  nominally  without  reference  to  any 
reserve  requirement.  If  the  Federal  reserve  banks  and  the 
Federal  Reserve  Board  take  this  view,  it  will  be  possible, 
with  the  consent  of  these  bodies,  to  meet  the  problem 
entirely  by  rediscountinf?. 

Ways  in  which  Problem  Can  be  Handled. — No  account 
has  been  taken  in  the  above  calculations  of  any  reduction 
in  the  liabilities  of  the  banks  through  the  calling  of  loans, 
the  sale  of  securities  or  the  failure  to  renew  commercial 
paper  now  held  by  them,  which  would  place  them  in  funds 
with  which  a  part  of  their  obligations  could  be  met.  We  will 
leave  the  discussion  of  this  phase  of  the  matter  until  we 
have  examined  the  position  of  the  New  York  banks  at  the 
period  of  greatest  strain. 

Beginning  with  the  twenty-fifth  month  the  reserve  pay- 
ments of  all  classes  of  national  banks  will  reach  their  maxi- 
mum, both  as  regards  the  cash  in  their  vaults  and  pajTnents 
to  the  Federal  reserve  institutions.  From  the  end  of  the 
twenty-fifth  to  the  beginning  of  the  thirty-sixth  month, 
after  the  establishment  of  the  Federal  reserve  banks,  all 
classes  of  banks  will  be  holding  the  maximum  vault  reserve, 
while  the  deposited  reserve  with  the  Federal  reserve  banks 
will  have  reached  the  maximum  specified  by  the  law.  This  is 
a  crucial  point  in  the  problem  of  readjustment,  and  if  it  is 
safely  passed  the  country  may  feel  reasonably  certain,  bar- 
ring some  unforeseen  contingency,  that  the  condition  will 
steadily  improve  thereafter. 

Problem  of  Readjustment  Primarily  a  Problem  of 
Securing  Cash. — The  problem  of  readjusting  reserves  is 
primarily  a  problem  of  securing  cash.  When  the  necessary 
supply  has  been  acquired  by  the  reserve  banks  the  crucial 
point  has  been  passed.  Of  course,  we  must  remember  that 
after  thirty-six  months  from  the  establishment  of  the  Fed- 
eral reseiwe  bank,  of  which  each  particular  institution  is  a 
member,  the  optional  reserve,  which  we  have  presumed  will 
be  left  Avith  the  present  reserve  agents,  must  be  transferred 
to  the  bank's  vaults  or  to  the  Federal  reserve  bank.  What 
effect  this  change  will  have  upon  the  central  reserve  city 


SHIFTING  OF  RESERVES  305 

banks  is  not  considered  in  this  connection,  but  is  treated 
in  the  succeeding  chapter. 

Stress  at  the  Beginning  of  the  Twenty-fifth  Month. — 
During  the  interval  from  the  twenty-fifth  to  the  thirty- 
sixth  month,  the  effect  of  the  new  reserve  requirements  upon 
the  central  reserve  city  banks,  under  each  of  our  five  assump- 
tions, would  be  as  is  shown  on  page  3U(J. 

Necessity  for  Rediscounts. — At  a  glance  we  see  that 
throughout  this  period  the  central  reserve  city  banks,  under 
every  assumption,  will  have  a  deficit.  In  other  words  it  will 
be  impossible  for  them  to  finance  out  of  the  surplus  in  their 
vaults,  released  by  lower  reserve  requirements,  the  demands 
which  will  be  made  upon  them  in  each  case  by  the  reserve 
city  and  country  banks.  Again  we  have  assumed  that  the 
central  reserve  city  banks  will  endeavor,  in  so  far  as  is 
possible,  to  make  their  payments  to  the  Federal  reserve 
banks  out  of  the  cash  in  their  vaults,  resorting  to  rediscounts 
only  when  and  to  the  extent  that  may  be  necessary.  While 
this  is  contrary  to  what  will  actually  occur,  because  the 
central  resei've  city  institutions,  seeing  that  they  must  redis- 
count, may  begin  to  do  so  at  an  earlier  date,  yet  for  our  pur- 
pose it  is  the  most  satisfactory  way  to  work  out  the  calcula- 
tion. After  all,  what  we  are  endeavoring  to  ascertain  is  the 
extent  to  which  rediscounts  will  be  necessary  in  order  to 
enable  the  central  resei've  city  banks  to  handle  their  part 
of  the  problem.  The  difference  in  the  results  under  each 
assumption,  of  course,  is  determined,  as  in  the  preceding 
calculation  concerning  the  first  twelve  months,  by  the  extent 
of  the  withdrawals  by  the  country  and  reserve  city  banks. 
These  withdrawals  range  from  some  $116,000,000  to  $3G6,- 
000,000  and  $250,000,000  will  probably  cover  every  reason- 
able contingency.  This  difference  determines  almost 
directly  the  extent  to  which  the  central  reserve  city  institu- 
tions may  rediscount. 

Can  the  Banks  Finance  these  Withdrawals  through 
Rediscounts? — Tender  tlie  first  assumption,  whore  the  re- 
serve city  and  country'  banks  withdraw  as  little  as  possible, 
financing  themselves  from  their  own  vaults  as  far  as  possible, 
20 


306       OPERATION  OF  THE  NEW  BANK  ACT 


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SHIFTING  OF  RESERVES  307 

the  central  reserve  city  institutions  would  have  to  rediscount 
slightly  less  than  $17,000,000.  Where  the  country  banks 
withdraw  one-half  of  their  contributions  to  the  reserve  banks 
equally  from  the  reserve  city  and  central  reserve  city  insti- 
tutions, while  the  reserve  city  banks  finance  themselves  as 
far  as  possible  from  their  own  cash,  the  necessary  rediscounts 
would  amount  to  something  less  than  $25,000,000.  If  the 
country  banks  should  withdraw  their  entire  contributions 
from  their  reserve  city  and  central  reserve  city  agents,  in 
equal  proportions,  while  the  reserve  city  institutions 
finance  their  own  contributions  and  the  withdrawals  of 
the  country  banks  as  far  as  possible  from  their  excess  cash 
holdings  over  the  required  reserve,  the  central  reserve  city 
banks  will  be  forced  to  rediscount  something  over  $108,- 
000,000  of  paper.  Under  the  fourth  assumption,  where 
country  banks  and  the  reserve  city  banks  as  a  class  each 
supply  from  their  cash  holdings  one-half  of  their  pajTuents 
to  reserve  banks  withdrawing  the  balance,  in  the  case 
of  country  banks,  one-half  from  the  reserve  banks 
and  one-half  from  the  central  reserve  city  banks, 
respectively,  while  in  the  case  of  the  reserve  city  banks 
the  entire  withdrawal,  namely,  one-half  of  their  con- 
tribution, of  necessity  being  from  their  central  reserve 
agents,  the  central  reserve  city  institutions  will  be  forced 
to  rediscount  $51,000,000.  Under  the  fifth  assimiption, 
where  the  country  banks  and  the  reserve  city  banks,  each  as 
a  class,  insist  on  maintaining  their  present  cash  holdings, 
the  country  banks  drawing  their  payments  in  equal  propor- 
tions from  the  reserve  and  central  reserve  agents  respec- 
tively, while  the  reserve  city  banks  withdraw  their  entire 
contributions  from  the  central  reserve  city  banks  up  to  the 
amount  of  their  reseiwe  balance,  if  necessary^  the  rediscounts 
required  of  the  central  reserve  city  institutions  would 
amount  to  over  $221 .000,000. 

The  Problem  of  Rediscounting  to  Create  Balances 
with  Reserve  Banks. — How  do  these  necessaiy  rediscounts 
compare  with  the  reserve  with  the  Federal  reserve  banks, 
which  under  the  law  can  be  created  bv  rediscounts,  amount- 


308       OPERATION  OF  THE  NEW  BANK  ACT 

ing  to  one-half  of  the  total  payments  for  this  purpose  to 
these  institutions  ?  Again  we  presume  that  throughout  this 
calculation  the  central  reserve  city  institutions  would  prefer 
to  carry  the  optional  reserve,  amounting  to  five-eighteenths 
of  the  total,  with  the  Federal  reserve  bank  rather  than  in 
their  own  vaults,  because  by  so  doing  they  could  make  up 
one-half  of  it  through  rediscounting — thus  reducing  the  cash 
which  must  be  supplied  by  this  amount,  for  if  they  kept 
it  in  their  own  vaults  they  would  be  required  to  provide  cash 
for  the  entire  amount.  Under  the  first  assumption,  the 
payment  to  the  Federal  reserve  bank,  including  the  required 
seven-eighteenths  and  the  optional  five-eighteenths  of  the 
total  reserve,  would  aggregate  $169,566,000.  Of  this,  pre- 
suming the  Federal  reserve  banks  were  willing,  $84,783,000 
could  be  created  by  rediscounts.  In  this  case,  however,  the 
rediscounts  necessary  would  be  only  $16,566,000.  In  the 
second  assumption  the  aggregate  payments,  required  and 
optional,  to  the  Federal  reserve  bank  would  total  $168,- 
396,000,  of  which,  with  the  consent  of  the  reserve  banks, 
$84,198,000  could  be  created  by  rediscounts.  Against  this 
the  required  rediscounts  would  amount  to  $24,565,000.  In 
the  case  of  the  third  assumption  the  payments,  required 
and  optional,  to  the  Federal  reserve  banks  aggregate  $156,- 
149,000,  of  which  $78,074,000  can,  with  the  consent  of  the 
reserve  banks,  be  created  by  rediscounts.  In  this  case,  how- 
ever, the  central  reserve  city  institutions  would  have  to  re- 
discount $108,247,000  of  paper,  leaving  a  deficit,  if  such 
it  might  be  termed,  of  $30,172,000  to  be  handled.  Under 
the  fourth  assumption,  the  payments,  required  and  optional, 
to  the  Federal  reserve  banks  total  $164,537,000,  of  which 
$82,268,000  can  be  created,  with  the  consent  of  the  reserve 
banks,  through  rediscounts.  Against  this  the  necessarv 
rediscounts  aggregate  only  $50,943,000.  Under  the  worst 
assumption,  the  fifth,  the  payments  from  the  stand- 
point of  the  central  reserve  institutions  to  the  Federal  re- 
serve banks,  required  and  optional,  amount  to  $139,606,000. 
of  which  $69,803,000  could,  with  the  consent  of  the  reserve 
banks,  be  created  by  rediscounts.     However,  the  central 


SHIFTING  OF  RESERVES  309 

reserve  city  institutions  would  have  a  deficit  of  $221,292,000, 
or  $151,489,000  more  than  they  could  meet  through  redis- 
eounting  one-half  of  their  total  payments  to  the  Federal 
reserve  banks. 

Summing  up,  we  see  that  only  under  the  third  and  fifth 
assumptions  will  any  extraordinary  methods  be  required  to 
enable  the  central  reserve  city  institutions  to  meet  the  with- 
drawals of  country  and  reserve  city  banks,  presuming  the 
Federal  reserve  banks  will  allow  the  central  reserve  city 
banks  to  build  up  one-half  of  their  reserve  with  them 
through  rediseounting.  Under  assumption  three,  the  deficit 
over  and  above  the  permissible  rediscount  of  one-half  of  the 
reserve  payments  to  the  Federal  reserve  banks  would 
amount  to  something  over  $30,000,000,  while  under  the 
worst  assumption  it  would  exceed  $151,000,000.  Presum- 
ing that  either  assumption  might  coincide  with  later  devel- 
opments, how  can  these  deficits  be  financed  ? 

Courses  of  Action  Open  to  Banks  in  Raising  Funds. — 
Generally  speaking,  three  courses  of  action  are  open  to  the 
central  reserve  city  institutions.  In  the  first  place,  if  the 
Federal  reserve  banks  are  willing,  these  institutions  can 
rediscount  this  deficiency  nominally  without  reference  to 
building  up  their  reserve  requirements,  aggregating,  under 
the  worst  conditions,  something  over  $151,000,000  above  the 
permissible  limit.  This  would  not  require  the  central  re- 
serve city  banks  to  turn  away  any  borrowers  who  had  become 
accustomed  to  rely  upon  them  for  accommodation.  As  a 
second  alternative,  the  central  reserve  city  banks  could  bor- 
row, either  abroad  or  from  national  and  State  banks  through- 
out the  country,  against  collateral,  or  by  the  sale  of  securi- 
ties which  they  o^^^^,  finance  the  deficit,  aggregating  under 
the  worst  assumption  $151,000,000,  and  thus  avoid  the  neces- 
sity of  curtailing  their  operations.  The  third  alternative 
is  for  the  central  reserve  city  banks  to  reduce  their  opera- 
tions by  the  amount  of  the  deficit.  That  is  to  say,  they  can 
require  the  pajnnent  of  call  loans  and  can  collect  maturing 
commercial   paper,    which    they    have    bought    from    note 


310      OPERATION  OF  THE  NEW  BANK  ACT 

brokers,  to  a  sufficient  extent  to  put  them  in  funds  to  meet 
these  deficits,  whatever  they  may  be. 

Which  of  these  three  courses  will  the  central  reserve  city 
banks  adopt?  It  is  difficult  and,  in  fact,  unsafe  to  make 
any  prophecy.  The  objection  to  the  first  method  of  large 
rediscounts  is  that  it  will  put  these  banks  very  heavily  into 
debt ;  it  will  require  the  complete  reversal  of  banking  senti- 
ment against  the  practice  of  rediscounts,  and,  looked  at  from 
the  national  stand-point,  will  create  a  questionable  situation 
by  having  some  thirty-six  banks  indebted  to  the  Federal 
reserve  banks  to  an  enormous  extent.  However,  it  may  be 
advisable,  in  spite  of  these  objections,  for  the  central  reserve 
city  banks  to  adopt  this  course.  To  do  so  would  involve 
the  smallest  disturbance  of  present  methods  of  financing 
business,  avoid  any  violent  contraction  of  credit,  and  so  long 
as  the  lending  policy  is  intelligently  handled,  no  serious 
dangers  need  develop  for  the  banks  themselves.  If  this  plan 
were  adopted,  the  banks  could  shift  some  of  their  borrowers 
over  to  other  institutions  as  fast  as  conditions  might  make 
it  possible,  thereby  reducing  their  borrowing  from  the  Fed- 
eral reserve  banks  and  readjusting  business  conditions 
slowly,  and  with  due  regard  to  the  delicacy  of  the  situation. 

The  second  plan  under  which  the  central  reserve  city 
banks  will  borrow  from  other  national  banks,  from  State 
banks,  or  abroad,  is  not  likely  to  be  followed  to  any  extent. 
There  is  no  well-developed  channel  through  which  such  bor- 
rowings could  be  handled,  and  the  possibility  of  arranging 
it  after  the  Federal  reserve  banks  have  been  created  is  still 
further  lessened.  The  Federal  reserve  banks  are  the  natural 
places  to  which  banks  will,  and  should  turn,  to  borrow.  Loans 
can  be  arranged  with  them  more  easily  and  with  less  danger 
than  with  any  other  class  of  banks,  and  hence,  if  borrowing 
is  to  be  done,  it  is  almost  certain  it  will  be  from  the  Federal 
reserve  institutions. 

Probabilities  of  a  Curtailment  of  Loans. — Looked  at 
from  the  stand-point  of  prudence  and  conservative  banking, 
the  third  alternative  appears  to  be  the  most  inviting.  Why 
should  the  central  reserve  city  banks  plunge  into  debt  in 


SHIFTING  OF  RESERVES  311 

order  to  finance  borrowers  when  the  logic  of  the  situation 
indicates  that  these  customers  must  sooner  or  later  be 
dropped  ?  If  the  central  reserve  city  banks  borrow  heavil}-, 
such  a  course  will  be  prompted  either  by  a  desire  to  avoid 
any  serious  disturbance  of  commercial  borrowing  or  to 
hold  this  business  as  long  as  possible  in  the  hope  that  some 
method  may  be  devised  by  which  it  can  be  preserved. 

As  has  been  elsewhere  pointed  out,  the  central  reserve  city 
banks  are  heavy  buyers  of  commercial  paper  from  note 
brokers,  and  discount  a  large  amount  of  paper  of  big  coi-- 
porations  which  borrow  directly.  There  is  no  moral  or 
banking  obligation  to  continue  loans  where  the  firms  whose 
paper  is  owned  are  not  depositors.  The  purchase  of  this 
paper  was  prompted  solely  by  the  desire  to  invest  funds  at 
a  profitable  rate  of  interest.  To  refuse  to  buy  other  paper 
when  these  investment  holdings  mature  will  not  deprive  the 
bank  of  any  of  its  depositors  or  involve  any  sacrifice  to  the 
institution.  Whatever  hardship  is  created  will  fall  upon  the 
firms  which  are  seeking  loans  which  the  note  brokers  may  be 
unable  to  place  because  one  of  their  best  markets  has  sud- 
denly vanished.  These  business  coneeras  are  scattered 
throughout  the  country — a  great  majority  of  them  not  being 
located  in  New  York,  Chicago  and  St.  Louis — and  the  dis- 
turbance in  business  conditions  will  not  affect  these  cities 
any  more  than  it  will  any  other  section.  Central  reserve 
city  banks  can,  therefore,  well  say  that  the  burden  of  carry- 
ing these  business  firms  should  be  assumed  by  the  entire 
country  and  not  be  one  which  they  alone  must  handle. 

Who  will  be  Affected  by  a  Reduction  in  Loans? — 
According  to  the  compilation  made  by  Mr.  Alexander  Gil- 
bert, set  forth  in  detail  in  the  preceding  chapter,  the  loans 
made  by  tlie  New  York  City  institutions,  disregarding 
Chicago  and  St.  Louis,  to  borrowers  situated  outside  of  thnt 
city,  aggrogntc  over  $0^2,000,000.  It  is  safe  to  presume 
that  the  loans  similarly  made  in  Chicago  and  St.  Louis  would 
raise  the  total  to  $1,200,000,000.  The  deficit  to  be  met  is  less 
than  twenty-five  per  cent  of  this  amount. 

Again,  tlie  New  Yoi'k  City  national  banks  had  loans, 


312       OPERATION  OF  THE  NEW  BANK  ACT 

according  to  Mr.  Gilbert,  amounting  to  about  $265,000,000 
to  Wall  Street  brokers,  while  the  country  banks  had  out- 
standing $175,000,000  of  direct  loans,  which  were  made 
by  the  New  York  City  banks  as  their  agents.  It  is  ver>' 
probable,  particularly  in  the  absence  of  abnormal  interest 
rates  for  call  loans,  that  the  country  banks  would  withdraw 
a  large  proportion  of  these  Wall  Street  loans  in  financing 
the  readjustment  of  their  reserve  requirements.  If  they 
should  do  so  it  would  naturally  not  affect  the  amount  of 
withdrawals  from  the  central  reserve  city  banks  for  the 
latter  would  be  forced,  to  a  large  extent,  to  take  over  these 
loans  just  as  they  have  been  compelled  to  do  in  the  past. 
It  can  be  readily  seen  that  the  $440,000,000  of  stock  exchange 
loans  furnishes  another  possible  source  from  which  the  cen- 
tral reserve  city  institutions  can  make  up  whatever  deficit 
they  must  handle. 

Will  the  Stock  Market  Have  to  Bear  the  Burden? — 
Which  course  will  they  prefer  to  adopt?  Will  the  national 
banks  of  the  country,  irrespective  of  class,  force  this  contrac- 
tion in  loans  upon  the  stock  exchange  ?  The  popular  verdict 
will  be  emphatically  in  favor  of  such  a  course,  and  good 
banking  would  dictate  that  so  far  as  possible,  and  without 
serious  unsettlement  of  stock  exchange  values,  this  policy 
should  be  adopted.  To  contract  the  discounts  of  commercial 
paper  will  profoundly  unsettle  business,  and  should  be 
resorted  to  only  as  the  last  expedient.  It  is  clear  that  under 
the  worst  assumption,  the  New  York  institutions  will  be 
able,  by  one  or  the  other  of  these  methods  or  by  a  com- 
bination of  them,  to  handle  any  withdrawals  which  are  likely 
to  occur. 

No  Inherent  Defect  in  Readjustment  Provisions. — 
It  is  clear  that  up  to  the  end  of  the  thirtieth  month  the 
Federal  Reserve  Act's  provisions  concerning  the  readjust- 
ment of  reserves  are  inherently  sound  under  ordinary'  busi- 
ness conditions.  In  the  absence  of  any  disturbance,  such 
as  a  panic,  a  war  involving  the  United  States,  or  a  great 
national  catastrophe,  there  is  no  reason  why  the  readjust- 
ment of  reserves  can  not  be  successfully  accomplished,  and 


SHIFTING  OF  RESERVES  313 

without  any  serious  disturbance  to  business.  Our  examina- 
tion of  the  amount  of  rediscounting  which  must  be  done  by 
central  reserve  city  banks  has  been  based  upon  the  worst 
assumptions.  As  a  matter  of  fact,  the  probable  extent  of 
rediscounting  is  not  likely  to  be  nearly  as  great  as  would 
be  indicated  by  the  fifth  assumption.  It  is  interesting  to 
speculate,  although  no  one  can  really  tell,  which  one  of  the 
above  assumptions  will  most  likely  accord  with  future  de- 
velopments. The  range  between  the  first  and  fifth  assump- 
tions will  cover,  it  is  believed,  every  possible  contingency, 
but  which  of  the  intervening  cases  will  prove  to  be  the 
most  accurate,  we  can  only  infer. 

It  is  obvious  that  the  question  is  largely  determined  by 
the  course  which  the  reserve  city  and  country  banks  will  take 
with  reference  to  the  cash  holdings  they  must  keep  over  and 
above  the  minimum  vault  reserve  required.  The  only  light 
which  we  can  get  upon  the  probable  course  of  action  is  in 
conditions  at  the  present  time.  According  to  the  compilation 
of  the  Comptroller  of  the  Currency  as  of  October  21,  1913, 
the  country  banks  were  holding  $294,180,000  of  cash,  while 
the  minimum  cash  reserve  required  was  $222,959,000.  Their 
excess  cash  holding,  therefore,  was  $72,221,000,  a  sum 
equivalent  to  1.9  per  cent  of  their  deposits  subject  to  reserve 
requirements.  In  other  words,  the  country  banks  were  hold- 
ing not  a  six  per  cent  vault  reserve,  which  was  the  minimum 
specified  in  the  National  Bank  Act,  but  a  7.9  per  cent  vault 
reserve.  In  our  investigation  of  the  probable  readjustment 
of  reserves  of  reserve  city  banks,  we  noted  that  on  October 
21,  1913,  these  institutions  were  carrying  between  $10.- 
000,000  and  $11,000,000  of  cash  in  their  vaults  over  and 
above  the  legal  minimum  which  thev  were  required  to  so 
hold. 

What  is  the  Most  Likely  Estimate  of  the  Extent  of 
Withdrawals? — Will  the  conntr^^  banks  and  the  reserve  city 
banks  feel  that  they  must  have  the  same  margin  in  dollars 
in  their  vaults  over  and  above  the  new  reserve,  which  they 
have  felt  was  necessan'-  under  old  conditions?  There  are 
many  reasons  why  this  assumption  may  not  accord  with  the 


314       OPERATION  OF  THE  NEW  BANK  ACT 

facts,  but  let  us  presume,  for  the  sake  of  argument,  that  this 
view  will  be  adopted  by  the  country  banks  and  the  reserve 
city  institutions.  The  second  assumption  is  predicated  upon 
the  supposition  that  country  banks  will  withdraw  something 
over  $63,000,000  from  the  reserve  city  and  central  reserve 
city  banks  during  the  first  year,  not  because  they  need  this 
money  to  make  payment  to  the  Federal  reserve  banks,  for 
they  can  do  that,  practically  speaking,  from  their  own  vaults, 
but  because  they  desire  to  have  surplus  cash  approximating 
this  amount  in  their  vaults  after  these  payments  have  been 
made.  During  the  third  year  the  third  assumption  presumes 
that  the  country  hanks  will  withdraw  about  $60,000,000  more 
than  they  must  withdraw  for  the  purpose  of  making  pay- 
ments. As  far  as  the  country  banks  are  concerned,  there- 
fore, the  second  assumption  during  the  first  year  and  the 
third  assumption  during  the  third  year  would  accord  very 
closely  with  the  present  policy,  as  regards  surplus  vault 
reserves,  now  pursued  by  the  country  banks.  As  far  as  the 
reserve  city  institutions  are  concerned,  the  withdrawals 
during  the  first  year  under  the  second  assumption  are  less 
by  about  $9,000,000  than  would  be  the  case  should  they  de- 
sire to  keep  surplus  cash  holdings  of  $10,000,000  over  and 
above  their  minimum  vault  reserve.  During  the  third  year 
the  estimated  withdrawals  by  the  reserve  city  banks  under 
the  second  assumption  are  between  $10,000,000  and  $11,- 
000,000  less  than  would  be  the  case  should  they  desire  to  keep 
their  same  actual  cash  holdings.  Under  the  third  assimip- 
tion,  which  we  have  seen  may  accord  most  nearly  with  the 
policy  to  be  pursued  by  the  country  banks,  the  reserve  city 
institutions  are  presumed  to  withdraw  between  $10,000,000 
and  $11,000,000  less  than  would  be  the  case  if  they  should 
desire  to  keep  the  same  actual  amount  of  cash  on  hand, 
over  and  above  the  minimum  requirements  which  they  now 
hold. 

Therefore,  to  sum  up.  the  second  assumption  may  be  said 
to  roughly  indicate  conditions  during  the  first  year,  while 
the  third  assumption  almost  coincides  with  what  will  occur 
during  the  third  year.    If  we  turn  to  our  calculations  con- 


SHIFTING  OF  RESERVES  315 

ceming  the  central  reserve  city  banks,  we  will  find  that 
under  the  second  assumption  in  the  first  year,  the  central 
reserve  city  institutions  would  have  a  cash  surplus,  after 
making  payments,  of  $53,000,000,  a  sum  sufficient  to  enable 
them  to  finance  the  requirements  which  would  be  placed 
upon  them.  Under  the  third  assumption  in  the  third  year, 
the  required  rediscounts  amount  to  $108,000,000,  and  if  we 
add  $10,000,000  additional  withdrawals  by  the  reserve  city 
banks  over  and  above  the  minimum  specified  under  this 
assumption  to  give  them  surplus  till  money,  the  necessary 
rediscounts  would  be  raised  to  approximately  $118,000,000. 
This  conclusion,  moreover,  is  based  upon  the  presumption 
that  the  United  States  deposits  will  be  withdrawn  from 
both  the  reserve  city  and  central  reserve  city  banks.  If 
they  are  allowed  to  remain  with  the  reserve  city  banks  they 
would  cut  down  the  necessary  withdrawals  from  the  central 
reserve  city  banks  in  the  third  year  and  under  the  third 
assumption,  by  about  $35,000,000.  Presuming  that  the 
United  States  deposits  are  allowed  to  remain  with  the  cen- 
tral reserve  city  institutions  and  that  the  withdrawals  of  the 
raserve  city  banks  have  been  reduced  to  $35,000,000  because 
the  United  States  deposits  have  been  allowed  to  continue 
with  them,  the  rediscounting  which  will  be  necessary  for  the 
central  reserve  city  banks  is  almost  cut  in  half,  not  exceed- 
ing, under  this  assumption,  over  $61,000,000. 

Again  it  should  be  repeated  that  this  is  but  a  prognosti- 
cation. However,  taking  everything  into  consideration,  the 
rediscounting  which  the  central  reserve  city  banks  will  be 
compelled  to  make  will  not  probably,  under  any  circiun- 
stances,  exceed  $150,000,000.  It  should  also  be  borne  in 
mind  that  there  is  no  real  necessity  for  rediscounting  by  the 
country  banks  and  the  reserve  city  banks  to  finance  the  read- 
justment of  their  reserves  during  the  first  three  years. 


CHAPTER  XXVI 
The  Final  Stage  in  the  Readjustment  op  Reserves 

Six  Steps  in  Shifting  Reserves. — In  shifting  reserve 
funds  from  present  reserve  agents  to  the  Federal  reserve 
banks  six  steps  are  taken.  An  analysis  of  the  process  will 
disclose  the  fact  that  the  strain  imposed  by  each  stage  is 
not  equally  severe.  Some  involve  a  great  amount  of  prep- 
aration and  have  a  more  far-reaching  effect,  when  com- 
pleted, than  the  others.  Three  steps  stand  out  clearly  as  the 
most  important,  the  others  representing  intermediate  varia- 
tions. 

Three  Steps  Stand  Out  as  the  Hard  Problems. — The 
first  step,  taken  when  the  Federal  reserve  banks  are  organ- 
ized, involves  the  sudden  shifting  of  a  large  amount  of 
money  to  the  reserve  banks.  The  coincident  reduction  in 
both  vault  reserves  and  in  the  total  resei^e,  as  we  have  seen, 
greatly  aids  in  the  solution  of  the  problem.  The  second 
point  of  great  stress  will  be  reached  at  the  beginning  of  the 
twenty-fifth  month  after  the  establishment  of  the  reserve 
banks.  At  that  time  the  obligatory  payments  on  account  of 
reserves  will  reach  their  maximum.  Upon  the  principle  of 
the  last  straw  breaking  the  camel's  back,  it  is  apparent  that 
the  successive  payments  to  the  reserve  banks  will  involve 
a  continually  increasing  strain  on  the  member  institutions, 
and  that  if  this  point  of  maximum  compulsory  contribu- 
tions can  be  safely  passed  a  great  victory  will  have  been  won. 

In  preceding  chapters  we  have  reviewed  at  length  these 
two  periods  of  stress.  We  have  seen  that  the  first  can  be 
managed  with  little  difficulty,  and  that  through  the  power 
of  rediscounts  the  present  reserve  institutions  can  meet  all 
probable  demands  in  the  second  period.  There  remains  for 
consideration  the  third  and  final  period,  occurring  at  the 
end  of  the  thirty-sixth  month  after  the  establishment  of  the 
reserve  banks.  At  this  time  the  Act  requires  the  shifting 
of  the  optional  balances,  which  theretofore  might  have  been 
carried  with  member  bank  reserve  agents,  into  the  banks' 

316 


FINAL  STAGE  IN  READJUSTMENT  317 

vaults  or  to  the  reserve  banks.  We  have  heretofore  pre- 
sumed that  the  entire  optional  balance  will  be  carried  with 
member  bank  reserve  agents. 

It  has  seemed  best  to  leave  the  study  of  this  final  read- 
justment for  separate  treatment,  (1)  because  by  this  time 
the  reserve  banks  will  have  such  large  resources  and  should 
be  so  well  established  that  conditions  wall  be  very  much 
better  than  during  the  earlier  stages;  (2)  because  as  a 
result  of  the  size  of  the  reserve  banks  and  several  years 
of  experience,  rediscounting  could  be  much  better  handled 
than  at  first,  and  (3)  because  the  lapse  of  three  years  will 
give  the  member  banks  an  excellent  opportunity  gradually 
to  shift  their  loans  and  to  realize  on  their  assets  in  prepara- 
tion for  the  final  readjustments. 

The  Final  Stage. — What  is  the  amount  which  each  class 
of  national  bank  will  be  compelled  to  transfer  from  their 
old  reserve  agents  to  their  own  vaults  or  to  the  reserv^e 
banks  at  the  end  of  the  third  year?  A  positive  answer  to 
this  question  is  very  difficult  to  formulate.  We  can  tell 
with  considerable  accuracy  what  may  happen  during  the 
first  year,  and  we  may  approximate  with  much  less  definite- 
ness  what  will  occur  at  the  beginning  of  the  twenty-fifth 
month.  When  we  come  to  the  end  of  the  thirty-sixth  month 
we  can  give  nothing  but  a  general  approximation,  based 
upon  our  conclusions  in  the  preceding  calculations,  and 
using  the  data  as  of  October  21,  1913.  So  many  things 
can  happen  in  three  years  and  conditions  may  so  radically 
change,  that  even  though  we  were  sure  of  the  exact  policy 
to  be  followed  by  each  class  of  banks,  no  absolute  conclu- 
sions can  be  formed.  The  estimates  given  in  this  chapter 
are  to  be  taken  as  suggestive  illustrations  of  how  the  prob- 
lem may  be  worked  out.  They  do  not  pretend  to  be  an 
authoritative  finding  of  exactly  what  will  occur. 

We  will  remember  that  our  previous  study  indicated  that, 
at  the  end  of  the  thirtieth  month,  the  countrv  banks  would 
probably  have  balances  with  present  reserve  agents  rang- 
ing somewhere  between  $316,122,000  and  $424,687,000, 
while  at  that  time  they  could  count  $60,210,000  of  these 
balances  as  their  optional  reserve.    In  all  probability  these 


318       OPERATION  OF  THE  NEW  BANK  ACT 

country  banks,  when  the  final  stage  is  reached,  will  transfer 
the  optional  proportion,  amounting  to  some  $60,000,000,  to 
the  reserve  banks  rather  than  to  their  own  vaults.  If  the 
former  course  is  pursued  the  balance  will  earn  interest,  if 
the  reserve  banks  should  decide  to  pay  interest  on  deposits. 
If  no  interest  is  paid  this  course  is  nevertheless  the  wisest, 
for  cash  in  the  vault  earns  nothing  and  contributes  no  di- 
rect advantages,  while  a  deposit  with  the  reserve  bank 
gives  the  member  bank  a  better  standing  with  the  reser\'e 
bank,  greater  consideration  when  it  desires  rediscounts, 
■and  better  facilities  for  selling  drafts  or  handling  foreign 
exchange  operations. 

Optional  Reserve  will  Probably  be  Transferred  to 
Reserve  Banks. — It  would  therefore  appear  practically 
certain  that  the  country  banks  will  transfer  the  $60,000,000 
optional  reserve  to  the  Federal  reserve  banks.  This  must 
be  accomplished  by  drawing  on  the  reserve  city  and  central 
reserve  city  institutions  for  this  amount.  We  shall  assume 
as  before  that  each  class  of  institution  furnishes  one-half 
of  this  sum.  When  the  readjustment  of  reserves  had  been 
completed  the  country  banks  would  still  have  balances 
with  former  reserve  agents  of  from  $256,000,000  to  $364,- 
000,000,  no  part  of  which  could  be  included  in  their  reserve 
calculation.  Whether  these  huge  balances  will  remain  with 
the  former  reserve  agents  after  this  time  must  be  left  for 
later  consideration. 

At  the  end  of  the  thirtieth  month  the  reserve  city  banks 
had  on  deposit  with  their  reserve  agents,  according  to  our 
previous  assumptions,  a  balance  ranging  from  $53,000,000 
to  $153,000,000.  Against  this  they  were  counting  some 
$53,000,000  as  their  optional  reserv^e  on  deposit  with  mem- 
ber bank  reserve  agents.  With  further  withdrawals  of  say 
$30,000,000  by  country  banks  at  the  end  of  the  thirty-sixth 
month,  and  with  the  necessity  of  shifting  some  $53,000,000 
additional  on  their  own  account  to  the  Federal  reserve 
banks,  it  is  evident  that  they  will  make  large  withdrawals 
from  the  central  reserve  city  banks.  Their  balances  with 
these  institutions  can  no  longer  be  counted  as  a  part  of  their 
reserve,  and  with  this  change  the  two  per  cent  interest  paid 


FINAL  STAGE  IN  READJUSTMENT  319 

thereon  will  cease  to  prove  very  attractive.  There  is  no 
reason  why  the  reserve  city  banks  should  rediscount  at  say 
three,  four  or  five  per  cent  in  order  to  provide  the  neces- 
sary funds  when  they  have  this  surplus  earning  much  less 
than  the  rediscount  rate.  If  the  clearing  and  collection 
service  of  the  reserve  banks  is  ever  to  prove  satisfactory, 
and  a  substitute  for  the  methods  now  employed,  it  should 
certainly  do  so  by  the  end  of  the  third  year.  It  is  unlikely 
that  at  this  time  the  reserve  city  banks  would  have  to  pre- 
serve considerable  balances  with  present  reserve  agents, 
merely  for  the  purpose  of  selling  exchange  and  handling 
collections. 

Burden  of  Furnishing  Final  Payments  will  Fall  on 
Central  Reserve  Cities. — In  view  of  these  factors  the  con- 
elusion  would  appear  to  be  inevitable  that  the  burden  of 
furnishing  the  funds  for  the  final  adjustment  would  be 
directly  or  indirectly  forced  back  upon  the  central  reserve 
city  banks  by  both  the  reserve  city  and  the  country  banks. 
If  this  should  prove  to  be  the  case,  the  balances  of  the  re- 
serve city  banks  with  reserve  agents,  after  the  final  step 
had  been  taken,  would  range  roughly  from  nothing  to  some 
seventy  odd  million  dollars. 

Probable  Withdrawals  from  Central  Resfirve  Cities. — 
It  would  be  entirely  possible  to  make  a  theoretical  calcula- 
tion, following  the  same  methods  pursued  in  our  previous 
calculations,  to  ascertain  in  detail  the  exact  effect  and  ex- 
tent of  these  withdrawals  upon  each  class  of  institution. 
We  have,  however,  at  this  point  proceeded  so  far  from  the 
solid  foundation  of  conditions  as  of  to-day,  and  would  be 
compelled  to  make  so  many  arbitrary  assumptions  that  the 
calculation,  aside  from  exhibiting  a  method,  which  has 
already  been  done,  would  have  no  great  practical  value. 
For  this  reason  we  will  content  ourselves  with  general 
approximations. 

Roughly  speaking,  the  final  stage  in  the  readjustment 
of  reserves  will  involve  the  following  withdrawals  from  the 
central  reserve  city  banks,  presuming  that  the  countrj^  banks 
and  reserve  city  banks  do  not  make  any  part  of  their  final 
payments  from  their  own  vaults,  which  would  be  very  un- 
likely: 


3^20       OPERATION  OF  THE  NEW  BANK  ACT 

1.  Withdrawals  of  country  banks  direct  from  central 

reserve  city  banks,  representing  one-half  of  tlieir 

linal  payment,  say, $30,000,000 

2.  VVitlidrawals  of   reserve  city   banks   as 

follows:  (a)  a  sum  representing 
tlieir  payments  to  country  banks,  or 
one-liaif  of  the  final  payments  of 
those  institutions,  less  the  fifteen 
per  cent  reserve  carried  against  this 
deposit,  which  presumably  will  be 
included  as  a  part  of  the  withdrawal, 

say,    $25,500,000 

(b)    the  entire  amount  of   payments 
of    the    reserve    city    banks,    trans- 
ferring their  optional  reserve,  say,  .  .        53,000,000 

78,500,000 


Total   $108,500,000 

Assuming  that  the  credit  balances  of  the  reserve  city  banks 
with  the  central  reserve  city  banks  were  only  $53,000,000 
at  the  end  of  the  thirtieth  month,  which  was  the  minimmn 
amount  according  to  our  preceding  investigation,  the  total 
withdrawals  from  the  central  reserve  city  banks  would 
amount  to  $83,000,000.  As  a  basis  for  illustration  we  may 
assume,  therefore,  that  the  central  reserve  city  banks  will  be 
called  upon  to  refund  to  their  correspondents  between 
$83,000,000  and  $108,500,000. 

Lowering  Vault  Reserves  at  End  of  Three  Years 
will  Have  Little  Effect. — At  the  end  of  the  third  year  the 
vault  reserve  of  the  country  banks  is  reduced  from  five- 
twelfths  to  four-twelfths  of  their  total  reserve,  while  the 
vault  reserve  of  the  reserve  city  banks  is  reduced  from  six- 
fifteentlis  to  five-fifteenths  of  their  total  reserve.  In  both 
cases,  however,  the  total  reserve  remains  the  same.  It  is 
improbable  that  the  banks  will  run  their  vault  reserves  down 
at  this  time  to  any  extent,  because  to  pay  it  to  the  Federal 
reserve  bank  will  not  help  them  to  meet  the  final  adjust- 
ment. If  they  did  so  they  could  not  thereby  reduce  the 
amount  of  their  final  withdrawals  from  their  depositaries. 
It  would,  figuratively  speaking,  merely  be  shifting  money 
from  one  pocket  to  another. 

However,  the  withdrawals  from  the  central  reserve  city 


FINAL  STAGE  IN  READJUSTMENT  321 

bauks  may  be  less  than  the  amoimtij  above  indicated.  We 
must  remember  that  the  growth  of  this  nation  in  three  years 
is  tremendous,  and  by  that  time  the  increase  in  the  resources 
of  the  country  banks  and  of  the  reserve  city  banks  may  have 
been  so  great  as  materially  to  reduce  these  calls. 

On  the  other  hand,  the  withdrawals  from  New  York  may 
possibly  be  much  larger  than  is  iudicated  by  the  above 
tigures.  AVe  must  recollect  that  with  the  expiration  of  the 
thirty-sixth  month  after  the  establishment  of  the  reserve 
banks,  the  balances  now  carried  with  the  present  reserve 
agents  can  not  be  counted  as  a  part  of  the  cash  reserves  of 
the  member  banks.  These  balances  may  be  left  with  these 
banks  and  continue  to  receive  the  two  per  cent  interest 
heretofore  paid  upon  them,  or  they  may  be  withdrawn  and 
put  to  work  at  home.  One  of  the  most  serious  problems 
which  New  York  City  and  the  other  large  cities  will  have  to 
face  is  that  of  endeavoring  to  hold  this  country  money. 
If  the  country  banks  withdraw  the  remaining  surplus  bal- 
ances, amounting  to  an  enormous  total,  which  remain  after 
the  readjustment  of  resen^es  has  been  finally  completed,  the 
situation  confronting  the  New  York  banks  will  be  very 
difficult  to  handle. 

Grave  Problem  before  Big  City  Bankers. — The  prob- 
lem presented  to  the  big  city  bankers  will  be  of  the  gravest 
character.  There  is  a  possibility  that  the  New  York  City 
banks,  in  order  to  take  care  of  their  borrowers  to  whom 
credit  can  no  longer  be  extended,  because  of  the  decrease 
in  deposits,  may  induce  the  country  banks  to  lend  these  sur- 
plus balances  on  commercial  paper,  secured  or  unsecured. 
The  New  York  banks  might  offer  to  negotiate  these  loans 
as  the  agents  of  their  correspondents,  making  no  charge 
to  them  for  the  service.  Thus  the  small  banks  will  have  the 
advantage  of  the  greater  experience  and  observation  of  the 
big  city  banker  in  selecting  paper.  It  is  possible  that  the 
New  York  bankers  might  be  able  to  collect  some  compensa- 
tion from  the  borrowers,  or  from  the  note  brokoi*s  for 
performing  this  service.  However,  there  are  certain  diffi- 
culties which  will  probably  limit  the  extent  of  this  prac- 
tice. In  the  first  place,  the  ordinan'  banker  desires  to  have 
21 


322      OPERATION  OF  THE  NEW  BANK  ACT 

the  paper  which  he  has  purchased  in  his  own  portfolio.  He 
is  not  satisfied  to  have  it  in  the  possession  of  another  bank, 
and  while  this  is  not  an  insuperable  obstacle,  yet  it  intro- 
duces some  difficulties.  If  the  country  banker  can  use  his 
money  to  better  advantage  at  home,  he  w^ill  be  inclined  to 
withdraw  it  from  the  present  depositaries.  If  the  change  is 
gradual,  shifting  will  not  necessarily  mean  financial  strin- 
gency. 

Contraction  of  Loans  is  Probable. — In  connection  with 
our  discussion  of  the  course  which  will  be  adopted  by  the 
central  reserve  city  banks  in  meeting  the  heavy  with- 
drawals on  or  about  the  twenty-fifth  month,  some  considera- 
tion was  given  to  the  question  as  to  whether  the  New  York 
banks  would  endeavor  to  carry  their  present  volume  of 
loans  by  rediscounting,  in  so  far  as  they  would  be  per- 
mitted, in  order  to  secure  the  necessary  funds.  Our  con- 
clusion was  that  it  was  likely  that  the  New  York  banks  would 
contract  their  loans,  both  collateral  and  commercial  paper, 
because  they  Avould  not  be  permanently  able,  in  all  prob- 
ability, to  hold  this  trade.  This  conclusion  is  now  rein- 
forced to  a  considerable  extent  by  the  fact  that  still 
further  rediscounts  will  be  necessary  in  order  to  finance 
the  final  payments  incident  to  the  readjustment  of  the  re- 
serve requirements.  The  volume  of  rediscounts  which  the 
New  York  banks  would  have  to  negotiate,  if  they  did  not 
contract  loans,  would  be  so  large  that  it  is  very'  unlikely 
that  the  Federal  reserve  bank  of  New  York  would  be  able  to 
extend  the  necessaiy  accommodations.  It  is  also  an  open 
question  whether  the  Federal  Reserve  Board  would  be 
willing  to  permit  such  a  course.  It  is,  of  course,  possible, 
as  we  have  seen,  for  the  banks  to  meet  all  probable  with- 
drawals by  curtailing  loans  and  by  making  a  rea.sonable 
amount  of  rediscounts.  Perhaps  the  most  vital  point  devel- 
oped in  our  examination  of  the  shifting  of  the  reserv^es  is 
the  possible  necessity  for  remaking  the  channels  of  commer- 
cial and  financial  borrowing.  How  this  can  best  be  effected 
we  will  leave  for  later  consideration  in  connection  with 
our  study  of  the  effect  of  the  reserve  system  upon  New 
York  and  the  other  central  re.serve  cities. 


CHAPTER  XXVII 

Clearing  Checks  and  Drafts 

Importance  of  the  Problem  and  Present  Methods. — 
One  of  the  most  important  problems  in  modern  banking  is 
that  of  handling  the  large  number  of  checks  and  drafts  that 
are  deposited  in  the  course  of  each  day's  business.  These 
items  maj'  be  grouped  under  four  heads.  First,  those  that 
are  drawn  on  the  bank  receiving  them.  These  furnish  no 
difficulty,  as  they  are  at  once  charged  against  the  custo- 
mer's account.  Second  are  those  on  banks  in  the  same 
town  belonging  to  the  local  clearing  house.  Such  items  fur- 
nish relatively  few  problems,  since  they  may  be  promptly 
presented  for  payment.  Occasionally,  when  the  amounts  are 
large,  they  may  be  collected  by  runners  or,  as  it  is  the 
practice  in  some  communities,  for  example  in  Philadelphia, 
some  of  the  checks  may  be  delivered  direct  to  the  banks  on 
which  they  are  drawn  and  receipts  taken  for  them,  these 
receipts  being  cleared  at  the  clearing  house  instead  of  the 
checks  themselves.  The  third  category  includes  checks  on 
banks  in  the  same  city  which  are  not  members  of  the  clear- 
ing house.  These  are  treated  in  two  general  ways.  They 
are  either  collected  by  sending  out  runners,  who  present 
them  at  the  banks  on  which  they  are  drawn,  or  presented 
at  the  clearing  house  to  some  bank  that  represents  the  non- 
member  bank  and  clears  for  it. 

The  fourth  group  of  items  is  the  checks  and  drafts 
against  banks  in  other  communities,  which  are  handled  in 
many  different  ways,  each  bank  consulting  its  own  interests 
in  their  disposition.  Frequently  the  bank  will  merely  de- 
posit them  at  another  bank  with  which  it  has  an  account. 
Thus  some  trust  companies  deposit  them  with  national  banks 
which  assume  the  burden  of  collection  in  return  for  the 
profits  that  accrue  from  the  trust  company's  deposit  with 
them.     Another  method  is  to  deposit  them  with  a  corre- 

sies 


324       OPERATION  OF  THE  NEW  BANK  ACT 

spondent  bank  in  another  city.  This,  of  course,  throws  the 
burden  of  collection  upon  the  bank  that  receives  the  items. 
Still  another  solution  is  for  the  bank  originally  receiving 
them,  or  the  bank  with  which  they  have  been  redeposited, 
to  send  them  by  as  much  directness  as  possible  to  the  bank 
on  which  they  are  drawn.  Since  no  bank  in  the  United 
States,  however  large,  has  accounts  with  all  other  banks  in 
the  country,  it  is  impossible  always  to  do  this  with  exactness. 
Instead  they  must  frequently  be  sent  to  a  correspondent 
bank  located  in  the  same  general  section  of  the  country  as 
the  bank  on  which  the  checks  are  drawn.  This  latter  bank 
then  sends  them  to  their  destination,  or  to  some  other  bank 
that  is  more  nearly  in  the  immediate  vicinity  of  the  drawee 
bank. 

Disadvantage  of  Present  Methods. — Some  of  the  diffi- 
culties of  the  present  methods  of  handling  these  items  are 
obvious.  Very  few  arise  under  the  first  two  conditions  de- 
scribed, but  there  are  many  in  connection  with  the  other 
two  groups — especially  with  the  fourth.  The  disadvantages 
of  the  methods  now  used  are  to  be  found  (a)  in  the  loss 
of  time  in  getting  the  check  back  to  the  bank  on  which  it  was 
drawn;  (6)  the  expense  in  postage,  clerical  hire  and  loss 
of  interest  while  these  items  are  in  transit;  and  (c)  the 
charges  by  the  banks  for  the  service  of  collection  which,  it  is 
alleged,  are  sometimes  in  excess  of  the  actual  cost.  An 
illustration  given  in  Cannon's  ''Clearing  Houses"  makes 
the  loss  of  time  and  expense  clear.  In  one  case,  which  he 
designates  as  an  average  one,  the  collection  of  a  check  re- 
quired drawing  two  other  checks,  writing  four  letters,  and 
expending  eight  cents  in  postage,  while  the  original  check 
was  handled  seventy-five  or  more  times  by  a  score  of  clerks 
in  five  banks  in  three  different  cities.  ]\Iore  extreme  illus- 
trations might  be  found,  but  it  is  scarcely  fair  to  present 
them,  since  they  are  not  typical.  Some  idea  of  the  way  in 
which  collections  work  out  in  practice  is  given  by  the  actual 
experience  of  certain  bankers  in  the  East  who  have  received, 
in  the  course  of  business,  checks  on  a  southern  point,  say 
Florida.    Some  of  the  banks  on  which  these  checks  are  drawn 


CLEARING  CHECKS  AND  DRAFTS  326 

are  very  tardy  in  remitting,  and  after  considerable  delay 
often  send  in  payment  exchange  on  New  Orleans.  This  is, 
of  course,  not  cash  for  the  eastern  bankers,  who  are  com- 
pelled to  collect  the  New  Orleans  drafts.  When  remittance 
is  received  from  New  Orleans  it  is  usually  in  a  form  that  is 
fairly  satisfactory,  but  the  time  lost  in  collecting  from 
Florida  and  then  again  from  New  Orleans  adds  very  heavily 
to  the  expense. 

Heavy  Expense  in  Making  Collections. — The  general 
practice,  as  explained  by  different  bankers  who  testified 
before  the  Senate  Committee  on  Banking  and  Currency 
when  this  matter  was  under  discussion,  is  of  interest.  Some 
of  them  declared  that  when  they  received  checks  on  country 
banks  in  their  vicinity  and  sent  them  to  the  country  banks' 
correspondents  for  collection,  those  correspondents  objected 
to  having  their  balances  charged  at  once  with  the  amount 
and  insisted  that  time  be  allowed  for  them  to  remit.  When 
the  remittance  was  sent  it  was  for  the  face  of  the  check  less 
a  collection  charge.  Thus  the  delay  and  the  expense  incident 
to  the  transaction  was  thrust  upon  the  bank  in  the  reserve 
city.  In  some  cases  the  reserve  city  banks  have  compelled 
the  country  banks  to  meet  the  expense. 

The  cost  of  handling  these  items  was  investigated  by  a 
Committee  on  Inland  Exchange  for  the  Clearing  House 
Committee  of  the  New  York  Clearing  House  Association 
which,  on  November  4,  1912,  submitted  a  report  declaring 
that  the  gross  income  to  the  members  of  the  Clearing  House 
Association  from  collecting  exchange  during  the  year  1911 
was  $2,139,551.  Against  this  must  be  charged  as  exchange 
cost,  postage,  rent,  stationery,  salaries  and  loss  of  interest 
(cash)  a  total  of  $2,042,088.78,  which  left  a  net  income  of 
$97,467.22. 

This  report  was  rendered  shortly  after  accusations  had 
been  made  that  the  New  York  banks  were  charging  more 
than  they  should  for  the  collection  of  out-of-town  items. 
In  the  hearings  before  the  Pujo  Committee  that  was  investi- 
gating the  "Money  Trust,"  it  had  been  charged  that  the 
New  York  banl^s  received  about  $50,000,000  a  year  from  this 


32C       OPERATION  OF  THE  NEW  BANK  ACT 

source,  and  the  report  of  the  Committee  on  Inland  Exchange 
was  intended  as  an  answer.  Without  attempting  to  analyze 
the  matter,  we  shall  point  out  the  way  in  which  the  banks 
of  New  York  endeavor  to  shift  the  expense  of  collecting 
these  checks  from  their  own  shoulders  to  those  of  their  custo- 
mers. The  cities  of  the  country  are  divided,  under  the  rules 
of  the  New  York  Clearing  House,  into  three  classes.  The 
first  class  constitutes  those  known  as  discretionary  points. 
On  such  points  each  bank  may  exercise  its  own  discretion 
as  to  charges,  and  in  practice  few  are  made.  The  second 
group  consists  of  points  a  little  farther  distant.  On  these 
the  banks  bind  themselves  to  charge  a  uniform  rate  of  one- 
tenth  of  one  per  cent.  The  third  class  includes  all  other 
cities  within  the  United  States  and  items  on  them  are  charged 
at  the  rate  of  one-fourth  of  one  per  cent  to  cover  the  cost 
of  collection. 

In  Philadelphia  such  a  system  of  charges  does  not  pre- 
vail, but  instead  another  device  is  used  which  accomplishes 
much  the  same  purpose.  The  large  banks  pay  interest  on  the 
deposits  of  other  banks.  They  allow  interest  to  begin  im- 
mediately only  for  items  on  a  number  of  discretionary 
points  and  divide  the  rest  of  the  country  into  three  regions. 
Deposits  of  items  on  banks  in  the  first  district  receive  interest 
only  after  three  days,  with  items  draw^n  on  banks  in  the 
second  district  interest  begins  after  five  days,  while  with 
items  on  banks  in  the  rest  of  the  country  interest  commences 
after  seven  days. 

Collecting  Out-of-town  Items  through  Clearing 
Houses. — Disadvantages  in  these  various  practices  have 
been  recognized  by  the  banks,  and  several  methods  have 
been  introduced  here  and  there  with  a  view  to  improvement. 
Thus  the  Old  National  Bank  of  Spokane,  Washington,  en- 
deavors through  its  advertising  matter  to  persuade  bankers 
of  the  country  to  send  items  on  all  points  within  about  five 
hundred  miles  of  Spokane,  direct  to  it  for  collection,  urging 
that  if  this  practice  is  followed  much  unnecessary  time  and 
expense  will  be  saved.  More  important  are  the  methods 
employed  by  the  clearing  houses  of  Boston,  Kansas  City, 


CLEARING  CHECKS  AND  DRAFTS  32^ 

Atlanta  and  Nashville.  In  each  of  these  places  the  banks 
belonging  to  the  clearing  house  turn  into  it  the  cheeks  which 
they  receive  on  banks  within  a  considerable  area  adjoining 
the  city.  The  clearing  house  groups  them  and  sends  them 
out  for  collection,  thus  saving  a  large  amount  of  time  and 
expense.  These  devices,  while  helpful,  have  l)y  no  means 
solved  the  problem,  and  there  is  still  much  reason  for  charg- 
ing that  a  great  deal  of  waste  is  involved,  and  that  in  some 
cases  the  accusation  of  excessive  collection  charges  is  true. 

Provisions  of  the  New  Law. — The  Federal  Reserve  Act 
attempts  to  solve  this  problem  through  a  number  of  different 
provisions.  In  Section  13  authority  is  given  to  the  Federal 
reserve  banks  to  receive  on  deposit  from  member  banks  not 
merely  cash,  but  "checks  and  drafts  upon  solvent  member 
banks,  paj'able  upon  presentation;"  or,  solely  for  exchange 
purposes,  to  receive  from  other  Federal  reserve  banks  cash 
and  "checks  and  drafts  upon  solvent  member  or  other 
Federal  reserve  banks,  payable  upon  presentation."  In 
Section  16  every  Federal  reserve  bank  is  required  to  "re- 
ceive on  deposit  at  par  from  member  banks  or  from  Federal 
reserve  banks  checks  and  drafts  drawn  upon  any  of  its 
depositors,  and  when  remitted  by  a  Federal  reserve  bank, 
checks  and  drafts  drawn  by  any  depositor  in  Rny  other 
Federal  reserve  bank  or  member  bank  upon  funds  to  the 
credit  of  said  depositor  in  said  reserve  bank  or  member 
bank."  In  the  same  section  the  Federal  Reserve  Board  is 
authorized  to  fix  by  rule  "the  charges  to  be  collected  by  the 
member  banks  from  its  patrons,  whose  checks  are  cleared 
through  the  Federal  reserve  bank,"  and  also  "the  charge 
which  may  be  imposed  for  the  service  of  clearing  or  collec- 
tion rendered  by  the  Federal  reserve  bank."  Since  each  re- 
serve bank  is  required  to  receive  at  par,  from  member  banks 
or  other  reserve  banks,  items  draAvn  upon  any  of  its  deposi- 
tors no  charge  can  be  made  for  collecting  checks  upon  any  of 
its  members,  no  matter  from  what  source  received.  A 
charge  may  be  made,  however,  to  a  memlier  bank  for  the 
collection  through  another  Federal  reserve  bank,  or  other- 
wise, of  all  checks  drawn  against  member  banks  in  another 


328        OPERATION  OF  THE  NEW  BANK  ACT 

district.  This  charge  which  may  be  made  by  the  reserve 
bank  must  be  fixed  by  the  Federal  Reserve  Board.  Its 
amount,  as  well  as  the  charge  made  by  any  member  bank  to 
its  patrons  who  present  checks  for  collection,  will  presuma- 
bly not  be  fixed  exactly  but  merely  a  maximum  indicated. 

Another  provision  affecting  the  entire  country  is  also  to 
be  found  in  Section  16.  The  Federal  Reserve  Board  may, 
at  its  discretion,  exercise  the  functions  of  a  clearing  house 
for  the  reserve  banks,  or  may  designate  one  of  the  reserve 
banks  to  act  as  a  clearing  house  for  the  others,  and  may  also 
require  each  reserve  bank  to  act  as  a  clearing  house  for  its 
member  banks.  Finally,  in  Section  19,  there  is  found  the 
requirement  that  "no  member  bank  shall  keep  on  deposit 
with  any  nonmember  bank  a  sum  in  excess  of  ten  per 
centum  of  its  own  paid-up  capital  and  surplus,"  and  that 
''no  member  bank  shall  act  as  the  medium  or  agent  of  a  non- 
member  bank  in  applying  for  or  receiving  discounts  from  a 
Federal  reserve  bank  under  the  provisions  of  this  Act,  except 
by  permission  of  the  Federal  Reserve  Board. ' ' 

In  earlier  drafts  of  the  Act  an  attempt  was  made  to 
require  the  collection  at  par  of  the  checks  of  all  member 
banks  in  all  parts  of  the  country.  Much  objection  was  raised 
to  this  proposal  by  the  country  banks,  who  declared  that 
many  of  them  would  thereby  lose  a  large  source  of  income. 
It  was  maintained  that  many  of  these  institutions  received 
much  of  their  income  in  this  way,  and  if  any  provisions  were 
made  that  would  deprive  them  of  this  revenue,  it  would 
antagonize  them  and  prevent  them  from  entering  the  sys- 
tem. No  matter  what  the  reason,  the  bill  as  finally  passed 
does  not  compel  the  receipt  of  all  checks  by  the  Federal 
reserve  banks,  at  par,  but  merely  those  upon  its  own 
member  banks  and  upon  the  members  of  another  reserve 
bank,  if  remitted  by  the  reserve  bank  of  that  district.  With 
the  provision  in  this  modified  form,  the  intent  appears  to  be 
that  each  reserve  bank  shall  become  the  clearing  house  for  its 
district. 

Will  Present  Clearing  Houses  Be  Abolished? — How 
fully  this  will  be  realized  is  uncertain.    Some  have  suggested 


CLEARING  CHECKS  AND  DRAFTS  329 

that  each  reserve  bank  may  act  as  a  clearing  house  for  all 
member  banks  of  the  city  in  which  it  is  located.  Each  bank 
would  merely  deposit  its  items  on  all  member  banks  within 
the  city,  the  reserve  bank  being  required  to  receive  them 
"on  deposit  at  par."  If  this  should  occur  the  expense  of 
maintaining  a  clearing  house  will  be  placed  on  the  reserve 
bank,  and  clearing  houses  in  the  cities  where  reserve  banks 
are  located  (and  perhaps  where  there  are  branches)  would 
no  longer  be  needed. 

If  the  reserve  bank  does  not  wish  to  assume  the  burden 
there  seems  to  be  no  alternative  unless  it  is  in  the  authoriza- 
tion in  the  Act  specifying  that  the  Federal  Reserve  Board 
may  impose  a  charge  ' '  for  the  service  of  clearing  or  collec- 
tion rendered  by  the  Federal  reserve  bank."  Since  the 
checks  and  drafts  themselves  must  be  received  "on  deposit 
at  par"  the  only  method  of  making  a  charge  would  seem 
to  be  a  periodical  assessment  on  each  bank,  on  the  basis  of 
the  proportion  which  its  clearings  bear  to  the  total.  Such 
a  charge  could  be  made  so  heavy  that  the  banks  would  pre- 
fer to  keep  their  present  clearing  house  organization,  or  so 
light  that  they  would  find  it  more  profitable  to  use  the 
reserve  banks. 

Heavy  Expense  Involved. — By  such  a  method  each 
reserve  bank  will  be  able  to  attract  or  repel  the  deposit  of 
checks  and  drafts  by  all  of  its  member  banks.  In  Boston 
it  has  been  found  that  two-thirds  of  the  total  expense  of 
operating  the  clearing  house  is  due  to  the  cost  of  handling 
the  out-of-town  items  and  that  when  volumes  are  compared 
they  cost  thirty  times  as  much  as  items  on  banks  within 
the  city.  The  checks  and  drafts  must  be  taken  "on  deposit 
at  par,"  but  the  expense  may  be  charged  back  on  each  mem- 
ber in  some  indirect  manner.  Whether  this  is  done  will 
be  purely  a  question  of  policy  to  be  decided  by  the  Federal 
Reserve  Board.  If  the  earnings  of  the  reserve  banks  make 
it  possible  the  entire  burden  of  collection  may  be  assumed 
by  them  in  order  to  increase  their  influonfe  nnd  prestige. 
If  earnings  are  smnll  these  charges  may  be  too  heav^'. 

Probabilities  seem  to  be  in  favor  of  each  reserve  bank 


330      OPERATION  OF  THE  NEW  BANK  ACT 

taking  such  action  as  will  send  to  it  all  possible  items  from 
its  district.  This  seems  the  more  likely  when  it  is  recalled 
that  collection,  so  far  as  the  reserve  bank  is  concerned,  is 
accomplished  by  at  once  charging  each  item  against  the 
account  of  the  bank  upon  which  it  is  drawn.  There  will  be 
no  loss  of  interest  to  the  reserve  bank  while  the  amount  is 
being  collected.  Deposits  of  drafts  on  the  government's 
account  will  be  taken  at  par  because  the  government  will, 
of  course,  have  an  account  with  each  of  the  reserve  banks. 
Checks  and  drafts  on  its  own  depositors  must  be  taken  at  par 
when  remitted  by  another  reserve  bank. 

Collections  between  Districts. — Since  reserve  banks 
may  keep  accounts  with  each  other  for  exchange  purposes, 
it  seems  fair  to  conclude  that  drafts  on  each  of  them  will  be 
taken  by  each  of  the  others  at  par.  If  this  is  so,  its  possible 
significance  is  tremendous.  Let  us  suppose  that  a  business 
man  in  District  No.  1  must  remit  to  a  creditor  in  District 
No.  7.  He  may  send  a  check  on  his  local  bank,  but  on  it  there 
may  be  imposed  a  collection  charge  in  the  other  district.  To 
avoid  this  he  will  not  send  a  check,  but  will  purchase  from 
his  local  bank,  perhaps  at  par,  a  draft  on  the  reserve  bank 
of  his  district.  This  draft,  when  received  by  the  creditor  in 
District  No.  7,  will  be  taken  to  the  creditor's  local  bank 
M'hich  will  take  it  at  par,  since  the  reserve  bank  of  that  dis- 
trict will  probably  do  the  same. 

If  the  assumption  we  have  made  proves  true,  checks  and 
drafts  on  all  member  banks  within  its  district  and  on  reserve 
banks  everywhere  within  the  United  States  will  pass  at  par, 
and  the  arrangement  will  add  greatly  to  the  prestige  and 
power  of  the  reserve  system.  It  will  also  mean  a  saving 
to  business  men  of  hundreds  of  thousands  of  dollars  in  col- 
lection charges  every  year.  In  any  case  checks  and  drafts 
on  banks  in  a  single  district  will  doubtless  be  taken  at  par  or 
nearly  so  within  that  district,  and  charges  for  those  on  banks 
in  other  districts  will  be  made  ver\^  moderate  by  the  Federal 
Reserve  Board.  This  does  not  mean,  of  course,  that  their 
collection  will  cost  nothing,  but  that  the  cost  will  be  assumed 
by  the  reserve  banks  or  assessed  back  upon  the  member 


CLEARING  CHECKS  AND  DRAFTS  331 

banks.  The  work  and  the  expense  involved  in  such  an  under- 
taking will  be  enormous. 

Maintenance  of  Present  Exchange  Accounts. — During 
the  first  thirty-six  months,  member  banks  may  continue  to 
keep  a  part  of  their  reserves  with  their  present  reserve 
agents  and  will  do  so  in  order  to  secure  the  two  per  cent  in- 
terest on  such  balances.  These  accounts  are  also  needed 
for  exchange  purposes.  Whether  they  are  entirely  abolished 
by  the  end  of  the  three  years  will  be  determined  by  several 
factors.  After  that  time  they  may  not  be  counted  as  part 
of  reserves  but  their  retention  will  be  determined  by:  (1) 
whether  the  out-of-town  bank  has  any  funds  over  and  above 
reserve  requirements  which  may  advantageously  be  loaned 
in  this  way;  and  (2)  whether  the  routine  of  rediscounting 
is  so  slow  and  the  standard  of  commercial  paper  set  by  the 
Reserve  Board  so  high  that  aid  may  not  quickly  be  secured 
from  a  reserve  bank  by  its  members.  If  the  service  offered 
by  reserve  banks  is  not  sufficiently  attractive,  member  banks 
may  continue  to  carry  accounts  with  the  institutions  that 
now  hold  them. 

We  have  not  as  yet  considered  the  checks  and  drafts 
upon  nonmember  banks.  Reserve  banks  may  receive  on  de- 
posit only  cash,  and  checks  and  drafts  upon  member  banks. 
Only  checks  and  drafts  upon  members  must  be  taken  at  par. 
There  is  no  provision  for  items  upon  nonmembers,  and  they 
are  thus  placed  at  a  disadvantage  so  serious  that  they  may 
be  forced  to  seek  membership. 


CHAPTER  XXVIII 

Mortgage  Loans  on  Farm  Lands 

Greater  Privileges  of  State  Banks. — A  factor  which 
has  been  largely  responsible  for  the  rapid  growth  in  the 
number  and  resources  of  State  banks  has  been  the  wider 
latitude  which  they  have  enjoyed  in  making  loans  and  in- 
vestments. One  of  the  most  important  advantages  which 
they  possess  is  the  power  quite  generally  given  to  make 
loans,  within  certain  limitations,  upon  real  estate  mort- 
gages. The  most  valuable  class  of  assets  of  any  nation  is 
its  land,  for  from  it,  directly  or  indirectly,  comes  all  the 
wealth  of  the  country  and  the  sustenance  of  its  people. 
With  banks  situated  in  rural  districts  or  in  the  smaller 
towns,  where  the  holdings  of  corporate  securities  are  not 
apparently  so  great,  the  most  cormnon  asset  of  value  is  real 
estate. 

Limitations  on  Real  Estate  Loans  by  National 
Banks. — The  National  Bank  Act  does  not,  in  set  terms, 
forbid  national  banks  loaning  upon  real  estate  mortgage. 
In  the  enumeration  of  the  powers  given  to  these  banks,  how- 
ever. Congress  was  careful  to  state  that  such  associations 
should  have  the  power  of  "loaning  monej^  on  personal 
security, ' '  while  the  Act  specifically  forbids  a  national  bank 
to  hold  real  property  except  under  certain  clearly  defined 
conditions. 

Section  5137  of  the  revised  statutes  dealing  with  this 
subject  reads  as  follows: 

"A  national  banking  association  may  purchase,  hold, 
and  convey  real  estate  for  the  following  purposes,  and  for 
no  others: 

"First.  Such  as  shall  be  necessary  for  its  immediate 
accommodation  in  the  transaction  of  its  business. 

"Second.  Such  as  shall  be  mortgaged  to  it  in  good  faith 
by  way  of  security  for  debts  previously  contracted. 
332 


MORTGAGE  LOANS  ON  FARM  LANDS   333 

"Third.  Such  as  shall  be  conveyed  to  it  in  satisfaction 
of  debts  previously  contracted  in  the  course  of  its  deahngs. 

"Fourth.  Such  as  it  shall  purchase  at  sales  under  judg- 
ments, decrees,  or  mortgages  held  by  the  association,  or  shall 
purchase  to  secure  debts  due  to  it. 

"But  no  such  association  shall  hold  the  possession  oL' 
any  real  estate  under  mortgage,  or  the  title  and  possession 
of  any  real  estate  purchased  to  secure  any  debts  due  to  it, 
for  a  longer  period  than  five  years." 

Under  the  decisions  of  the  courts,  the  Act  has  been  in- 
terpreted to  prohibit  a  national  bank  from  lending  money 
on  a  real  estate  mortgage,  and  such  mortgages  as  are  held 
by  the  national  banks  have  been  secured,  at  least  nominally, 
under  the  conditions  recited  in  the  above  section  of  the  Act. 
j\Iany  national  banks  have  complained  that  this  restriction 
places  them  under  a  severe  handicap  in  competing  for  busi- 
ness with  State  institutions,  and  that  instead  of  being  an 
advantage  to  them  it  is  an  element  of  weakness. 

Disadvantages  of  National  Banks  in  Dealing  with 
Farmers. — "When  money  is  loaned  to  a  farmer,  for  ex- 
ample, it  is  obvious  that  his  most  valuable  asset  is  his  farm, 
and  the  discount  of  his  note  is  justified  in  the  mind  of  the 
banker,  to  a  considerable  extent,  by  the  fact  that  he  is  the 
owTier  of  this  land.  In  the  event  of  his  failure  to  pay  the 
note  when  due,  the  bank  can  proceed  against  him  and  re- 
cover the  amount  of  the  loan  from  the  sale  of  the  property. 

If,  however,  the  note  is  to  run  for  a  considerable  period 
of  time,  the  bank  takes  a  certain  amount  of  risk',  which  is 
largely  of  a  personal  character.  If  the  farmer  is  dishonest 
or  singularly  unfortunate,  or  if  he  is  indnced  to  embark  in 
some  fake  mining  scheme  or  other  unsonnd  enterprise,  he 
may  lose  sight  of  prudence  and  place  a  mortgage  on  his 
farm  and  dissipate  the  money  arising  therefrom  before  the 
note  matures.  The  bank  would  then  find  itself  the  junior 
creditor,  and  would  be  powerless  to  inteiwene  and  prevent 
this  7'esult  from  r)ccurring.  It  must  not  be  inferred  from 
this  illustration  that,  as  a  general  rule,  banks  take  big  risks 
in  lending  monev  on  notes  of  farmers  or  of  other  owners  of 


334      OPERATION  OF  THE  NEW  BANK  ACT 

real  estate.  There  is,  however,  always  the  possibility  wliicli 
has  been  pointed  out,  and  from  a  legal  stand-point  the  bank, 
when  dealing  with  an  individual  concerning  whose  good 
judgment  there  might  be  some  doubt,  could  protect  itself 
by  taking  a  mortgage  upon  the  man 's  property  rather  than 
by  loaning  upon  an  unsecured  note. 

Organization  of  State  Institutions  by  National  Bank 
Stockholders. — As  a  result  of  this  decision,  the  stock- 
holders of  many  national  banks  have  felt  forced  to  adopt 
a  course  which,  from  many  points  of  view,  must  be  regarded 
as  an  evasion  of  the  spirit,  although  not  of  the  letter,  of  the 
National  Bank  Act.  The  owners  of  a  national  bank  or- 
ganize a  trust  company,  under  the  laws  of  the  State  in 
which  the  bank  is  situated,  in  many  cases  using  the  funds 
of  the  national  bank  to  pay  up  the  capital  of  the  trust  com- 
pany by  a  declaration  of  a  dividend  of  part  of  the  surplus 
of  the  national  bank.  Where  such  trust  companies  have 
been  organized,  it  is  quite  common  to  find  that  a  provision 
is  inserted  in  the  by-laws,  and  often  printed  upon  the  stock 
of  the  trust  company,  stating,  in  effect,  that  these  shares 
can  be  transferred  only  when  and  if  the  corresponding 
shares  of  the  national  bank  owned  by  the  same  stockholders 
are  also  transferred.  It  is  further  provided  that  the  same 
owners  shall  possess  both  the  bank's  and  the  corresponding 
trust  company's  stock.  While  this  provision  is  probably 
illegal  in  most  States  and  would  not  stand  a  test  in  court, 
yet  the  business  motives  underlying  the  situation  are  so 
plain  and  the  interests  of  the  stockholders  are  so  obvious 
that  there  has  never  been  any  serious  objection  raised  to 
this  practice  on  the  part  of  the  stockholders. 

Operation  of  Dual  Institutions. — Where  such  a  dual 
bank  and  trust  company  exist,  it  is  quite  common  to  find 
that  the  president  of  the  bank  is  the  president  of  the  trust 
company,  it  being  so  stipulated  in  the  by-laws,  while  the 
cashier  of  the  bank  acts  as  treasurer  of  the  trust  company, 
and  the  directors  of  the  one  institution  are  the  same  per- 
sons as  the  directors  of  the  other.  In  many  cases  both 
occupy  the  same  building,  their  quarters  being  divided  by 


MORTGAGE  LOANS  ON  FARM  LANDS   335 

a  glass  partition.  One  set  of  clerks  keep  the  books  and 
handle  the  business  of  the  trust  company,  while  another  set 
of  clerks,  on  the  other  side  of  the  partition,  keep  the  books 
and  handle  the  business  of  the  bank.  The  funds  of  the 
trust  company  are  kept  in  the  vaults  of  the  bank.  The 
meetings  of  the  directors  of  the  two  institutions  are  held, 
practically  speaking,  at  the  same  time. 

In  other  cases,  the  trust  company  occupies  a  building 
adjoining  that  of  the  bank,  with  a  communicating  door  be- 
tween the  two ;  or  if  deemed  expedient,  the  two  institutions 
are  separated  physically  if  not  actually.  At  a  glance,  this 
arrangement  would  seem  to  be  a  direct  evasion  and  open 
violation  of  the  National  Bank  Act;  and  yet,  where  dis- 
tinct corporate  entity  exists,  where  the  books  of  the  insti- 
tution are  kept  separate  and  the  funds  of  the  tnist  com- 
pany are  segregated  from  those  of  the  bank,  with  no  liability 
attaching  to  the  bank  for  the  obligations  of  the  company, 
except  for  the  cash  deposit  held,  there  is  really  no  strong 
reason  why  the  national  bank  should  be  undermined  or 
injured  by  the  existence  of  this  sister  corporation.  The 
arrangement  involves  merely  the  same  set  of  owners  who 
have  contributed  in  like  proportions  to  the  capital  of  both 
institutions,  the  same  directors  sitting  upon  the  boards  of 
both  institutions,  and  in  some  cases  the  officers  occupying 
the  same  relative  positions  in  botli.  This  practice  has  been 
developed  extensively  in  the  South  and  in  the  West,  and 
from  these  sections  came  a  very  strong  demand,  while  the 
Reserve  Act  was  under  consideration  in  Congress,  that  the 
national  banks  should  be  given  the  power  to  make  loans, 
under  proper  restrictions,  upon  real  estate  mortgages.  It 
was  argued  that  the  granting  of  this  power  would  do  much 
to  cause  State  institutions  to  take  out  national  charters, 
and  it  was  also  argued  that  jiLstice  and  good  banking  de- 
manded the  extension  of  this  privilege,  cntiivly  aside  from 
the  question  of  national  expediency. 

Why  the  National  Banks  Were  Denied  the  Right  to 
Buy  Mortgages. — Tii  defence  of  the  National  Hank  Act, 
it  should  be  stated  that  the  intention  of  Congress  was  to 


336       OPERATION  OF  THE  NEW  BANK  ACT 

provide  i'ur  the  iucorporatiou  ol  national  baniis,  whose  chiel 
business  would  be  the  receipt  of  demand  deposits  and  the 
investment  of  such  funds  in  a  manner  which  would  accord 
with  the  principles  of  sound  commercial  banking.  The 
prohibition  against  the  purchase  of  real  estate,  or  of  loans 
upon  real  estate  security,  was  based  upon  the  theory  that 
real  estate  is  a  slow  asset,  and  for  a  commercial  bank  whose 
deposits  are  subject  to  repayment  upon  demand  such  an 
asset  is  unsuited,  either  as  an  investment  or  as  security  for 
a  loan.  The  law,  therefore,  restrained  national  banks  from 
entering  this  field. 

Time  Deposits  and  the  Lending  Problem. — It  tran- 
spires, however,  as  we  have  seen,  that  a  large  proportion  of 
the  deposits  of  national  banks  are  time  deposits  existing 
either  in  the  form  of  savings  accounts  or  in  the  fonn  of 
time  certificates  of  deposit.  Experience  has  demonstrated 
that  these  deposits  are  reasonably  stable,  and  that  it  is  not 
necessary  to  invest  all  of  the  time  deposits  in  quick  assets. 
The  national  banks  hold  also  an  enormous  amount  of  in- 
vestment securities,  particularly  the  bonds  of  municipali- 
ties, railroads  and  public  service  corporations.  These  se- 
curities in  normal  times  can  be  marketed,  if  well  selected, 
with  some  dispatch  and  with  little  or  no  loss,  and  they  meet 
admirably  the  requirements  for  a  proper  investment  of  the 
more  stable  deposits  of  banking  institutions. 

In  agricultural  communities,  the  investment  of  large 
sums  of  money  in  the  securities  of  corporations  whose  prop- 
erties are  situated  hundreds  of  miles  distant,  is  regarded  by 
many  as  a  distinct  disadvantage.  The  argument  Is  ad- 
vanced that  the  neighborhood  suffers  a  distinct  loss  through 
the  departure  of  its  capital  to  other  communities,  and  that 
if  the  money  were  kept  at  home  it  would  increase  the  value 
of  every  man's  farm,  the  productivity  of  the  district  and 
the  thrift  and  wealth  of  its  citizens.  This  argument  is  one 
which  appeals  powerfully  and  is,  to  a  very  considerable 
degree,  founded  upon  solid  fact.  A  large  proportion  of 
good  farm  mortgages  in  the  agricultural  districts  are  created 
for  the  purpose  of  financing  improvements  to  the   farm 


MORTGAGE  LOANS  OX  F.VRM  LANDS       337 

which,  il"  wist4y  made,  will  iuerease  its  productivity  aud 
revenue  producing  power.  A  farmer  who  desires  to  buy 
an  extensive  outfit  of  machinery,  such  as  tractor  plows,  or 
who  wants  to  underdrain  a  part  of  his  land  or  to  plant  out 
a  section  of  it  in  an  orchard,  or  who  wishes  to  build  larger 
barns  for  the  purpose  of  housing  cattle  or  to  make  some 
other  outlay  for  some  similar  purpose,  can  not  expect  to 
pay  for  these  improvements  out  of  the  profits  of  a  single 
year.  In  fact,  it  will  take  him,  under  the  best  conditions, 
from  three  to  five  years  to  accumulate  a  surplus  sufficient 
to  extinguish  the  debt  or  to  have  a  sufficient  fund  on  hand 
to  insure  the  renewing  of  the  balance  of  the  mortgage. 
Such  loans,  when  intelligently  made,  are  absolutely  good. 
As  a  matter  of  record,  the  losses  are  very  small ;  and,  there- 
fore, the  security  afforded  by  such  collateral  is  as  good  as 
any  which  a  bank  can  purchase. 

Financing  the  Farmer. — In  contradistinction  to  this 
borrowing  on  mortgages  for  the  purpose  of  making  im- 
provements, farmers  borrow  to  a  considerable  extent  on 
four-montlis,  six-months  or  one-year  notes,  for  the  purpose 
of  financing  their  temporary  needs.  At  the  end  of  the 
growing  season  the  farmer  can  borrow  money  on  six-months 
paper,  for  example,  to  secure  funds  to  purchase  steers,  to 
which  he  will  feed  the  corn  which  he  has  grown  during  the 
summer,  selling  the  cattle  in  the  spring,  or  whenever  market 
conditions  seem  most  advantageous.  This  paper,  when  the 
loans  are  carefully  made,  is  exceedingly  good.  As  soon 
as  the  steers  are  shipped  to  the  market  and  sold,  the  bor- 
rowed money  is  returned  to  the  bank  that  advanced  it,  and 
thus  the  loan  is  automatically  liquidated  in  the  process  of 
the  transaction. 

To  meet  the  banking  needs  of  an  agricultural  commu- 
nity, therefore,  it  is  contended  that  national  banks  should 
be  enabled  to  conduct  both  kinds  of  business,  and  make 
part  of  its  loans  on  mortgages  and  part  on  connnercial 
paper.  In  support  of  the  contention  that  lending  money  on 
mortgages  does  not  mean  any  unusual  risk  or  hardship  on 
banking  institutions,  the  advocates  of  this  plan  cite  the 

22 


338       OPERATION  OF  THE  NEW  BANK  ACT 

experience  of  State  banks  when  permitted  to  make  such 
loans.  The  laws  of  many  of  the  States  permit  them  to  loan 
a  considerable  proportion  of  their  funds  upon  mortgages. 
For  example,  in  Michigan  the  law  allows  the  State  bank 
to  invest  fifty-one  per  cent  of  its  savings  deposits  in  mort- 
gages, obligates  the  institution  to  hold  fifteen  per  cent  of 
these  deposits  in  the  form  of  cash  reserves,  and  allows  the 
directors  to  loan  the  remaining  thirty-four  per  cent  as  they 
see  fit,  within  general  hmitations.  In  Massachusetts  seventy 
per  cent  of  the  savings  deposits  may  be  invested  in 
mortgage  loans. 

Experience  of  State  Banks  with  Mortgage  Lending. — 
Many  trust  companies,  all  of  which  are  organized  under 
State  charters,  have  been  successful  in  handling  real  estate 
loans.  The  institution  which  has  gone  farthest  in  this 
direction  of  any  trust  company  in  this  country  is  probably 
the  Mercantile  Trust  Company  of  St.  Louis,  of  Avhich  'Mr. 
Festus  J.  Wade  is  president.  This  institution  has  devel- 
oped a  very  large  business  in  placing  mortgages  upon  im- 
proved real  estate  of  every  desirable  sort,  including  office 
buildings  and  other  central  business  property,  apartment 
houses,  etc.,  the  mortgage  being  made  out  to  the  Trust 
Company  as  trustee.  Under  these  mortgages,  and  secured 
thereby,  the  Mercantile  Trust  Company  issues  bonds  in 
denominations  of  suitable  amount  and  sells  them  to  in- 
vestors. These  bonds  pay  from  five  to  six  per  cent,  and 
have  proved  very  attractive  to  the  people  of  that  district. 
There  is  no  doubt  that  the  granting  of  the  right  to  resei've 
city  banks  (in  addition  to  granting  the  privilege  to  coun- 
try banks)  to  make  farm  loans,  which  is  given  in  the  Federal 
Reserve  Act,  is  prompted  by  the  ver^'  strong  testimony  on 
this  subject  given  by  Mr.  Wade  before  the  Congressional 
committees.  Although  his  institution  is  located  in  a  central 
reserve  city,  and  therefore  the  example  of  his  work  was 
not  the  moving  consideration,  yet,  as  he  forcibly  pointed 
out,  the  banks  in  the  reserve  cities  are  to  a  large  degree  the 
central  institutions  for  the  surrounding  country  districts. 
Being  in  touch  with  the  city  investor,  and  being  also  the 
natural  and  logical  centers  for  the  surrounding  country, 


MORTGAGE  LOANS  ON  FARM  LANDS   339 

they  are  in  a  most  excellent  position  to  develop  a  good 
business  in  fann  loans. 

Bankers'  Position  on  Mortgage  Lending. — Western 
banks  were  almost  unanimous  in  advocating  that  national 
banks  be  given  the  privilege  of  making  farm  loans.  They 
based  their  advocacy  upon  the  almost  uniformly  desirable 
experience  which  State  banks  have  met  with  in  handling 
this  type  of  security.  ]\Iost  of  them  combated  strongly  the 
idea  that  the  farm  mortgage,  if  carefully  selected,  was  an 
inconvertible  security.  Several  instances  were  cited  where 
banks  in  the  IMiddle  West  have  succeeded  in  getting  through 
panicky  times,  such  as  the  fall  of  1893,  largely  by  inducing 
depositors  who  had  become  frightened  and  who  desired  to 
get  their  money  out  of  the  banks  to  accept  real  estate  mort- 
gages upon  nearby  farms,  which  were  held  by  the  banks. 
The  frightened  depositors  were  glad  to  take  such  mort- 
gages, because  they  felt  confidence  in  them,  and  because  the 
purchase  overcame  the  disadvantage  of  a  loss  of  interest. 

Provisions  of  Reserve  Act  concerning  Mortgage 
Loans, — It  was  admitted  by  practically  every  banker  who 
advocated  the  extension  to  national  banks  of  the  privilege 
of  making  farm  loans  that  this  privilege  should  be  given 
only  to  a  limited  extent;  and  that  the  limitation  should  be 
based  not  upon  the  size  of  the  bank,  but  either  upon  a  cer- 
tain proportion  of  its  capital  and  surplus  or  else  with 
reference  to  some  fixed  percentage  of  its  time  deposits.  In 
order  to  make  the  practice  good  banking  it  would  be  neees- 
sary%  moreover,  to  legalize  time  deposits  and  to  make  it 
possible,  through  the  building  up  of  public  sentiment,  for 
a  bank  to  insist  on  the  notice  incident  to  a  time  deposit,  and 
thus  enable  it  to  make  a  relatively  fixed  investment  of  such 
funds.  As  a  result  of  the  strong  representations  of  western 
and  southern  bankers,  the  following  provision  was  incor- 
porated in  the  Federal  Reserve  xVct: 

"Any  national  banking  association  not  situated  in  a 
central  reserve  city  may  make  loans  secured  by  improved 
and  unencumbered  farm  land  situated  within  its  Federal 
reserve  district,  but  no  such  loan  shall  bo  made  for  a  longer 
time  than  five  years,  nor  for  an  amount  exceeding  fifty  per 


340       OPERATION  OF  THE  NEW  BANK  ACT 

centum  of  the  actual  value  of  the  property  offered  as 
security.  Any  such  bank  may  make  such  loans  in  an  aggre- 
gate sum  equal  to  twenty-five  per  centum  of  its  capital  and 
surplus  or  to  one-third  of  its  time  deposits,  and  such  banks 
may  continue  hereafter  as  heretofore  to  receive  time  de- 
posits and  to  pay  interest  on  the  same. 

"The  Federal  Reserve  Board  shall  have  power  from 
time  to  time  to  add  to  the  list  of  cities  in  which  national 
banks  shall  not  be  permitted  to  make  loans  secured  upon 
real  estate  in  the  manner  described  in  this  section." 

Analysis  of  the  Provisions  of  the  Act. — Summarizing 
the  provisions  of  the  Act,  we  find  in  the  first  place  that 
every  national  bank  which  is  not  situated  in  a  central  re- 
serve city — that  is  to  say,  in  New  York,  Chicago  or  St. 
Louis — or  such  additional  prohibited  cities  as  the  Fed- 
eral Reserve  Board  may  add  from  time  to  time,  is  permitted 
to  make  farm  loans.  Such  loans  shall  be  confined  to  "im- 
proved and  unencumbered  farm  land,"  thereby  excluding 
timber  land,  undeveloped  mineral  land,  city  real  estate,  and 
many  other  classes  of  property  concerning  which  applica- 
tion might  be  made.  It  must  be  further  noted  that  the  land 
must  be  situated  in  the  same  Federal  reserve  district  as  the 
lending  bank,  that  the  loan  shall  not  exceed  one-half  of  the 
actual  value  of  the  property  offered  as  security,  and  shall 
be  a  first  mortgage  upon  the  property.  The  aggregate 
amount  of  loans  which  a  national  bank  may  make  on  such 
farm  land  shall  not  exceed,  in  the  aggregate,  one-fourth  of 
its  capital  and  surplus  or  one-third  of  its  time  deposits. 
Attention  is  directed  to  the  fact  that  the  Act  specifically 
confirms  the  right  of  the  national  bank  to  receive  time 
deposits. 

Can  National  Banks  Deal  in  Mortgages? — The  word- 
ing of  the  Act  is,  unfortunately,  not  clear  upon  a  very  im- 
portant matter,  although,  by  inference,  the  common-sense 
meaning  might  readily  be  read  into  the  statute.  It  is  prob- 
able that  the  national  banks  may,  in  time,  build  up  a  con- 
siderable business  in  loaning  money  upon  farm  mortgages 
and  then  resell  the  mortgages  to  its  depositors  or  to  other 
investors.    In  such  a  case,  the  bank's  profit  would  be  largely 


MORTGAGE  LOANS  ON  FARM  LANDS   341 

that  of  a  dealer  iu  mortgages.  Such  a  business  would  be 
advantageous  to  the  bank  because  it  would  draw  to  it  a 
larger  clientele ;  to  the  investor,  a  mortgage  purchased  from 
a  bank  would  appear  to  have  been  more  carefully  selected 
than  one  picked  up  from  the  ordinary  real  estate  agent. 

The  law  does  not  state  that  the  bank  shall  not  own,  at 
any  one  time,  real  estate  mortgages  up  to  a  certain  limit; 
but  states,  rather,  that  the  bank  shall  make  such  loans  only 
up  to  an  aggregate  sum.  If  a  bank  should  take  five-year 
mortgages,  such  as  are  authorized,  and  resell  them  within 
two  or  three  months,  it  can  be  readily  seen  that  it  would 
be  possible,  with  a  relatively  small  amount  of  money  tied 
up  in  this  class  of  investment  at  any  one  time,  to  do  a  very 
large  business  in  a  five-year  period.  If  the  statute  is  in- 
terpreted to  mean  that  the  bank's  ability  to  make  such 
loans  is  limited,  not  by  the  amount  which  it  owns,  but  rather 
b.y  the  amount  which  it  has  placed,  there  will  be  a  vast 
difference  in  the  effectiveness  of  this  provision  in  financing 
the  farmer.  However,  inasmuch  as  the  bank  in  selling  the 
mortgage  would  have  no  legal  obligation  to  see  that  it  was 
paid,  there  is  no  very  apparent  reason  why  a  national  bank 
should  not  be  allowed  to  deal  in  real  estate  mortgages, 
provided  it  does  not  have  more'  than  a  certain  amount  of  its 
own  funds  invested  in  them  at  any  one  time. 

This  is  the  preferable  interpretation  to  put  upon  this 
clause  of  the  Act.  It  is  interesting  to  speculate  upon  the 
effect  which  this  provision  will  have  upon  the  farm  security 
market.  It  is  evident,  of  course,  that  the  more  buyers 
that  are  created,  and  the  greater  the  potential  avenues  of 
disposal  for  mortgages,  the  more  convertible  become  such 
securities.  Any  one  who  has  investigated  the  mortgage 
market,  particularly  in  the  well  settled  sections  of  the 
West,  realizes  how  active  is  the  demand  for  choice  mort- 
gages. This  has  been  especially  true  in  the  last  few  years, 
for  the  more  progressive  life  insurance  comiianies  have  been 
very  wisely  putting  a  large  proportion  of  their  money  in 
real  estate  mortgages  rather  than  in  bonds.  The  real 
estate  mortgage,  because  it  has  a  short  maturity,  will  not 
depreciate  in   value  with   c'hnnL'os  in   Hn^  cronernl   lovel  of 


34!^      OPERATION  OF  THE  NEW  BANK  ACT 

interest  rates,  which  necessitate  a  writing  off  of  a  consid- 
erable part  of  the  investment.  This,  unfortunately,  has  been 
the  case  in  the  last  few  years  with  low  yield  railroad  bonds 
and  other  securities.  A  liigher  rate  of  interest  can  be  se- 
cured on  real  estate  mortgages  with  equal  safety,  and  thus 
the  returns  to  the  policy  holders  upon  their  savings  are 
enhanced.  If  the  national  banks  enter  the  market  as  pros- 
pective buyers,  the  farm  mortgage  should  become  an  even 
more  convertible  form  of  collateral. 

Banking  Limitations  on  Mortgage  Investments. — 
The  investment  of  money  in  farm  mortgages  carries 
with  it  certain  limitations  which  must  be  recognized.  In 
the  first  place,  a  farm  mortgage  can  not  be  rediscounted  at 
a  Federal  reserve  bank  or  used  there  as  collateral  for  a 
loan.  This  provision  is  a  very  proper  one ;  for  to  allow  the 
member  banks  to  use,  without  restriction,  farm  mortgages 
as  collateral  for  loans  would  mean,  in  substance,  that  it 
would  be  possible  thereby  to  expand  the  currency  of  the 
country  almost  indefinitely,  the  limit  being  fixed  by  the 
amount  of  farm  mortgages  outstanding.  This  practice,  if 
indulged  in  even  to  a  limited  extent,  would  lead  to  infla- 
tion, and  would  totally  destroy  the  objects  sought  after  by 
the  Act.  The  theory  of  note  issue  is,  as  we  have  seen,  that 
these  notes  shall  be  issued  to  finance  actual  commercial 
transactions,  and  that  when  these  transactions  are  closed 
and  settlement  made,  the  notes  issued  shall  be  retired  and 
thus  any  redundancy  prevented.  This  would  be  impossible 
were  the  Federal  reserve  banks  permitted  to  issue  notes 
upon  farm  mortgages  or  any  other  form  of  collateral 
security. 

Reserve  Act  not  a  Complete  Solution  of  Agricultural 
Banking  Problem, — It  must  also  be  remembered  that  the 
provision  allowing  the  national  banks  to  purchase  farm 
mortgages  is  not  intended  as  a  complete  solution  of  the 
problem  of  financing  the  farmer.  President  Wilson  has 
announced,  as  part  of  his  programme,  the  passage  of  a  law 
providing  for  the  establishment  of  agricultural  credit  banks 
in  this  country,  similar  to  those  which  exist  in  Europe, 
which  will  go  much  further  than  could  the  national  banks 
in  solving  this  problem. 


CHAPTER  XXIX 

How  THE  System  Wili.  Affect  the  Country  Banks 

Difficulty  of  Accurate  Estimates. — From  one  end  of  the 
country  to  the  other  is  arising?  the  inquiry,  "How  will  the 
new  system  affect  the  country  banks  ? "  Almost  every  news- 
paper contains  the  opinion  of  some  banker  or  student  of 
financial  affairs.  With  the  short  space  of  time  given  to  direc- 
torates and  officials  of  the  national  banks  to  decide  whether 
they  will  join  the  system,  becoming  member  banks,  or  take 
the  first  steps  looking  toward  their  dissolution  as  national 
institutions,  the  matter  is  one  of  vital  moment.  Any  answer 
to  the  question  will  be  largely  a  prophecy,  and  must,  to  a 
considerable  extent,  be  predicated  upon  assumptions  which, 
in  themselves,  are  matters  of  opinion.  Every  feature  of  the 
bill  has  a  direct  or  indirect  bearing  upon  the  answer  to  this 
question,  and  it  is  obviously  impossible  at  this  point,  even 
though  desirable,  to  make  an  adequate  summarj'  of  what 
has  been  said  in  preceding  chapters  bearing  upon  this  par- 
ticular class  of  institution. 

Prophecies  that  Country  Banks'  Profits  Will  Be  Cut.— 
At  the  present  time  the  most  important  consideration  in  the 
mind  of  the  average  banker  is  that  of  profits  under  existing 
conditions  compared  with  those  which  will  prevail  under 
the  new  Act.  The  more  remote  and  less  direct  considera- 
tions— the  advantages  which  may  accrue  in  the  course  of 
years — do  not  weigh  as  heavily  as  does  the  question  of  how 
it  will  affect  his  earnings  and  dividends  at  the  beginning. 
While  the  Federal  Reserve  Act  was  under  consideration  in 
Congress,  much  was  heard  of  its  unfavorable  nature  from 
the  stand-point  of  the  country  banker ;  and  a  large  number 
of  witnesses  appearing  before  the  committee  took  a  very 
decided  stand  against  the  law,  because  of  the  effect  it  would 
have  upon  the  profits  of  the  country  institutions.    The  Sen- 

343 


344       OPERATION  OF  THE  NEW  BANK  ACT 

ate  Committee  on  Banking  and  Currency,  in  order  to  secure 
something  tangible  as  to  the  effect  of  the  law  upon  the  profits 
of  the  various  classes  of  banks,  requested  the  Comptroller 
of  the  Currency  to  make  a  computation  "relating  to  the 
probable  gain  or  loss  in  the  earning  power  of  banks,  as  indi- 
cated, under  the  proposed  currency  bill  compared  with  the 
existing  law. "  In  response  to  this  request,  the  Acting  Comp- 
troller of  the  Currency  instructed  the  government  actuary 
to  prepare  a  computation  which  was  submitted  to  the  Com- 
mittee on  October  25,  1913.  Subsequent  to  that  date,  numer- 
ous changes  were  made  in  the  Federal  Reserve  Act  which 
would  materially  affect  this  computation,  which  is  to  be 
found  on  page  3130  et  seq.  of  the  Third  Volume  of  the 
Senate  Hearings. 

Method  of  Computing  Relative  Profits. — Following  the 
principle  devised  by  the  government  actuary,  except  where 
subsequent  modifications  of  the  law  make  changes  necessary, 
the  profits  of  the  country  banks  under  the  old  system  and 
under  the  Federal  Reserve  Act,  after  three  years  from  the 
date  on  which  it  is  actually  put  into  operation,  would  com- 
pare as  shown  on  page  345. 

In  working  out  this  computation,  an  effort  has  been 
made  to  make  it  as  nearly  typical  as  possible  of  the  con- 
ditions actually  prevailing.  To  this  end,  average  conditions 
have  been  taken  wherever  possible ;  that  is  to  say,  the  total  de- 
mand deposits  of  the  country'-  banks  in  the  continental 
United  States  have  been  divided  by  the  number  of  these 
banks  within  this  territory,  in  order  to  give  us  the  average 
demand  deposits.  The  same  has  been  done  with  time  de- 
posits, national  bank  notes  outstanding,  and  bonds  deposited 
with  the  United  States  to  secure  circulation  or  for  other 
purposes.  The  reserves  have  been  calculated  on  the  mini- 
mum allowed  by  the  National  Bank  Act  and  under  the  new 
law,  while  the  capital  stock  subscription  has  been  taken  on 
the  basis  of  three  per  cent  of  the  capital  and  surplus  of  the 
average  bank,  as  ascertained  in  the  same  manner. 

Compilation  of  Relative  Profits  for  the  Average  Bank. 
— Basing  our  calculation  on  these  assumptions,  we  find  that 


EFFECT  ON  COUNTRY  BANKS 


345 


AN  AVERAGE  COUNTRY  BANK 


Under  the  old 
system. 


After  three 
years. 


Demand  deposits 

Time  deposits 

Reserve  in  own  vaults 

Reserve  with  reserve  acents 

Reserve  with  Federal  reserve  banks 

National  bank  notes  outstanding 

United  States  deposits 

Bonds  deposited  with  the  United  States. . .  . 

Capital  stock  of  Federal  reserve  bank  (3  per 

cent) 


$350,000 

168,000 

31,080 

46,620 


68,000 

5,200 

72,800 


$350,000 

168,000 

16,800 


33,600 
66.000 


66,000 
4.150 


Decrease. 


Increase. 


Upon  loanable  funds: 

Decrease  in  reserves   (less  5  per  cent 

redemption  fund) 

Retirement  of  circulation 

Withdrawal  of  United  States  deposits. . 

Sale  of  bonds 

Purchase  of  stock  Federal  reserve  bank 


Total 

Net  increase 


Upon  income: 

Loss  of  profit   on   circulation   about  2 

percent 

Profit  on  balance  with  Federal  reserve 

bank  about  3  per  cent 

Loss  on  deposits  with  reserve   agents 

2  per  cent  

Dividends  on  stock  of  Federal  reserve 

bank  6  per  cent 

Profit  on  additional  funds  available  for 

lending  about  4  per  cent 

Total 


Net  gain  in  income. 


$2,000 
5,200 

'4,150 

'6,800 

$11,350 

$30,700 

$19,350 

$24.00 

$1,008 

932.40 

249 

774 

$956.40 

$2,031 

$1,074.60 

the  amount  of  money  represented  by  the  aggregate  of  the 
several  items  before  mentioned  is  reduced  from  $741,700 
to  $704,550.  The  larger  part  of  this  reduction  results 
from  the  decrease  in  the  required  resen'e  from  the  old  figure 
of  $77,700  to  the  new  level  of  $50,400.  In  calculating  the 
decrease  in  the  reserve  requirements  account  has  been  taken 
of  the  fact  that  the  five  per  cent  redemption  fund  can  no 


346       OPERATION  OF  THE  NEW  BANK  ACT 

longer  be  included  as  part  of  the  bank 's  reserve.  The  method 
followed  has  been  to  take  the  net  decrease  in  reserve  as 
between  the  conditions  under  the  National  Bank  Act  and 
under  the  new  Act,  three  years  after  the  establishment  of 
the  new  reserve  system,  subtracting  therefrom  the  amount 
of  the  five  per  cent  redemption  fund.  This  has  the  effect 
of  setting  off  the  five  per  cent  fund,  just  as  though  it  had 
been  included  as  an  increased  item  of  investment  upon  which 
no  income  would  be  derived. 

Turning  to  the  effect  of  the  changes  in  the  several  items 
of  deposits,  investments  and  reserve  requirements  upon  the 
decrease  or  increase  in  the  amount  of  loanable  funds,  we  find 
that  there  is  a  net  decrease  of  $19,350  in  the  amount  of 
funds  tied  up  at  present  under  the  old  law,  which  Avill  be 
released  for  other  purposes  under  the  new  Act. 

We  come  then,  finally,  to  the  question  of  what  changes 
this  shifting  of  funds  from  present  channels  will  have  upon 
the  income  of  the  bank.  According  to  the  method  followed 
by  the  Comptroller's  department,  it  would  appear  that  the 
country  banks  would  profit  as  the  result  of  the  new  law, 
and  that  the  average  bank  would  gain  $1,074.60  per  year, 
as  contrasted  with  its  present  income. 

It  is  very  likely,  however,  that  many  bankers  will  dis- 
agree with  the  assumption  of  the  Comptroller's  department 
that  there  will  be  a  profit  in  the  balance  of  the  country  bank 
with  the  Federal  reserve  bank,  equivalent  to  three  per  cent 
of  the  amount  of  such  balance.  This  conclusion  inferen- 
tially  assumes  that  the  Federal  reserve  bank  will  pay  interest 
at  a  rate  at  least  equal  to  that  now  paid  by  reserve  agents 
on  balances  now  deposited  with  them,  averaging  about  two 
per  cent  per  annum.  Elsewhere  it  has  been  pointed  out 
why  this  maj^  not  be  done.  No  explanation  is  forthcom- 
ing as  to  the  additional  one  per  cent,  or  as  to  why  the 
assumption  concerning  the  payment  of  interest  is  correct. 
The  additional  facilities  which  the  reserve  banks  can  offer 
to  the  country  institutions  through  the  handling  of  collec- 
tions, the  selling  of  exchange,  the  privilege  of  liberal  redis- 
counts, etc.,  may  indirectly  prove  equal  to  the  balance  of 


EFFECT  ON  COUNTRY  BANKS  347 

one  per  cent,  representing,  presumably,  these  factors  in  the 
Comptroller's  assumption. 

Can  the  Balances  with  Reserve  Agents  Be  Made  more 
Profitable? — If  a  bank  makes  liberal  rediscounts,  it  is 
very  possible  that  a  much  larger  sum  might  be  secured 
under  the  new  regime.  Presuming  that  the  bank  can  lend 
at  six  per  cent  and  can  rediscount  at  four  per  cent,  there 
will  be  a  profit  of  two  per  cent  on  the  money  thus  secured 
from  the  Federal  reserve  bank.  If  there  should  prove  to  be 
an  expansion  in  rediscounts  over  the  present  amount,  the 
additional  profit  arising  from  the  increased  business  would, 
presumably,  have  to  be  credited  to  this  item  in  the  Comp- 
troller's calculation. 

Many  criticisms  can  be  made  to  this  method  of  measuring 
the  material  benefits  of  the  new  Act  to  the  country  bank. 
The  calculation  is  presented  here  because  it  comes  from  a 
very  authoritative  source,  and  because,  in  so  far  as  it  goes, 
it  is  correct  with  the  possible  exceptions  hereinbefore  noted. 
The  Comptroller's  calculation,  however,  apparently  does  not 
entirely  cover  the  situation.  He  has  failed  to  take  into 
consideration  the  balances  which  the  country  banks  now 
have  with  their  reserve  agents,  but  part  of  which  they  may 
not  count  as  a  part  of  their  reserve.  The  National  Bank 
Act  permits  a  bank  to  count,  as  a  part  of  its  resei've, 
balances  with  reserve  agents  up  to  sixty  per  cent  of  the 
required  reserve.  On  October  21,  1913,  the  country  banks 
of  the  United  States,  excluding  Hawaii,  had  on  deposit  with 
reserve  agents  $534,733,083,  of  which  they  could  couut 
$320,033,974  as  a  part  of  their  reserve.  The  Comptroller 
has  failed  to  take  into  consideration  the  balance  of  $214,- 
099,099.  If  the  clearing  and  collection  facilities  of  the 
Federal  reserve  banks  prove  to  be  as  good  or  better  than 
those  now  provided  by  the  present  resei've  agents,  this 
surplus  balance  of  $214,699,099  can  be  withdrawn.  It  is 
certain  that  this  surplus  will  be  withdrawn,  provided  the 
country  banks  can  find  more  profitable  employment  for  it 
at  home.  Heretofore  country  banks  have  kept  a  consider- 
able surplus  with   reserve  agents,   over  and   above   their 


348       OPERATION  OF  THE  NEW  BANK  ACT 

deposit  reserve,  in  order  to  handle  any  demands  which  will 
be  made  upon  them  for  exchange.  If  they  keep  a  balance 
equal  only  to  the  amount  that  they  can  count  as  a  part  of 
their  reserve,  the  sale  of  drafts  or  clearing  operations  would 
cause  a  technical  deficiency  in  reserves.  Again  the  banks 
at  times  have  no  use  for  idle  funds,  and  send  them  to  New 
York,  because  of  the  two  per  cent  interest  they  can  receive 
thereon.  "While  it  is  not  certain  that  all  of  this  balance  can 
be  withdrawn,  yet  if  such  should  be  the  case,  the  results, 
according  to  the  Comptroller's  method  of  calculation,  would 
have  to  be  revised  as  follows: 


Presuming  sur- 
plus balance  with 

reserve  agent  ia 
$30,078  per  bank. 


Interest  on  surplus  funds  at  6  per  cent  withdrawn    from  reserve 

agents  after  3  years  have  expired $1,804.68 

Less  present  interest  received  thereon  at  2  per  cent  per  annum  601.56 

$1,203.12 

Add  profit  as  shown  by  Comptroller's  method  of  circulation.  .  .  1,074.60 

Total  additional  profits  under  new  system $2,277.72 

Ratio  to  average  capitalization  of  country  banks  (about  $85,800) ,  2.6  per  cent 


Of  course  this  result  must  not  be  taken  as  authoritative. 
It  is  only  inserted  as  suggestive  of  what  may  occur.  It  is 
impossible  to  determine  the  effect  of  the  new  Act  upon  the 
profits  of  the  country  banks.  To  make  such  an  estimate 
it  would  be  necessary  to  know  exactly  what  would  occur  with 
reference  to  the  shifting  of  reserves;  the  status  of  the 
national  bank  note ;  the  extent  to  which  rediseounting  will  be 
done ;  the  relative  success  of  the  new  machinery  to  be  pro- 
vided by  or  through  the  Federal  reserve  banks  for  the  col- 
lection of  checks  or  drafts ;  the  extent  to  which  the  business 
necessity  for  deposits  of  large  amounts  in  other  institutions 
will  be  reduced  or  obviated ;  and  manyother  similar  matter.s. 
No  one  can  answer  these  questions  at  this  time.  In  the  long 
run,  however,  it  must  be  obvious  that  if  the  Federal  Reserve 
Act  succeeds  in  its  purpose,  the  dependence  of  the  countiy 


EFFECT  ON  COUNTRY  BANKS  349 

banks  upon  the  reserve  city  and  central  reserve  city  banks 
will  be  greatly  reduced,  if  not  practically  eliminated.  If 
this  condition  develops,  the  profits  should  increase  through 
the  withdrawal  of  all  or  the  larger  proportion  of  these 
balances,  now  earning  a  very  nominal  rate  of  return.  The 
key  to  the  (luestion  of  profits  is  primarily  to  be  found  in  the 
course  which  will  be  pursued  with  reference  to  these  deposit 
balances. 

Other  Advantages  to  the  Country  Banks. — It  is  im- 
possible to  appreciate  at  this  time  the  incidental  and  col- 
lateral advantages  which,  if  the  Act  is  successful,  will  accrue 
to  the  country  banks.  The  mere  prestige  of  being  a  member 
bank  will  be  very  great,  and  should  have  a  much  larger  ele- 
ment of  value  than  has  attached  merely  to  being  a  national 
bank.  The  Federal  Reserve  Board  and  the  Federal  reserve 
banks  should  impose  much  stricter  standards  of  examination 
than  have  heretofore  prevailed.  This  should  reduce  bank 
failures  to  a  very  considerable  degree,  and  with  such  a 
reduction  will  come  a  general  popular  appreciation  of  the 
greater  safety  of  the  member  banks  over  nonmember  insti- 
tutions, which  will  be  subjected  to  less  rigid  scrutiny  and 
discipline.  IMoreover,  if  the  machinery  for  clearing  checks 
and  drafts  is  perfected  to  the  fullest  extent,  the  facilities 
which  a  member  bank  can  give  to  its  customers  should  be 
greatly  increased.  Checks  will  be  collected  more  promptly, 
collection  charges  will  be  altogether  eliminated  or  reduced, 
and  drafts  can  be  purchased  which  will  be  received  anywhere 
in  the  country.  These  and  other  advantages  will  be  appre- 
ciated by  the  business  public.  Finally,  the  additional 
powers  given  to  national  banks,  such  as  the  right  to  loan  a 
considerable  proportion  of  their  deposits  upon  real  estate 
mortgages,  and  to  act  as  executor,  administrator  and  trustee 
under  conditions  to  be  approved  by  the  Federal  Reserve 
Board,  will  have  a  positive  commercial  advantage. 

Looked  at  from  any  stand-point,  there  seems  to  be  no 
reason  to  doubt  that  the  country  banks  will  be  much  better 
off  as  member  institutions  than  they  would  ho  if  they  with- 
drew from  the  national  system  and  took  out  State  charters. 

Administrative  Changes  in  Banking  Legislation. — In 


350       OPERATION  OF  THE  NEW  BANK  ACT 

beginning  our  study  of  the  effect  of  the  law  upon  the  several 
classes  of  national  banks  some  account  must  be  taken  of 
those  changes  in  the  banking  law  which  will  modify  adminis- 
trative practices.  The  Federal  Reserve  Act  modifies  in  cer- 
tain respects  portions  of  the  National  Bank  Act  dealing  with 
administrative  matters.  These  changes  do  not  refer  solely 
to  the  country  banks,  and  what  follows  applies  with  equal 
force  to  reserve  city  and  central  reserve  city  institutions. 
In  the  main,  the  changes  are  for  the  purpose  of  giving  bind- 
ing legal  force  and  effect  to  administrative  rulings  and  prac- 
tices, heretofore  inaugurated  by  the  Comptroller  of  the  Cur- 
rency. These  practices  have  been  reasonably  well  observed, 
but  the  absence  of  specific  penalties  for  failure  to  meet  the 
requirements  of  the  Comptroller  has  been  in  some  cases  a 
source  of  weakness.  In  order  to  remove  the  loop-hole 
created  by  this  situation  the  Federal  Reserve  Act  has 
amended  the  National  Bank  Act,  in  order  to  grant  specific 
authority  for  the  enforcement  of  these  practices. 

New  Provisions  Concerning  Examinations. — One  of 
the  most  important  changes  consists  of  a  recasting  of  Sec- 
tion 5240  of  the  United  States  Revised  Statutes  dealing  with 
the  appointment  of  bank  examiners  and  their  compensation. 
By  the  amendment,  the  Comptroller  of  the  Currency  con- 
tinues as  before  to  appoint  the  bank  examiners,  but  the  law 
now  specifies  that  every  member  bank  shall  be  examined  '  *  at 
least  twice  in  each  calendar  year  and  oftener  if  considered 
necessary,"  instead  of  as  heretofore  that  the  bank  shall 
be  examined  "as  often  as  shall  be  deemed  necessary  or 
proper."  A  proviso  is  inserted  giving  to  the  Federal  Re- 
serve Board  power  to  authorize  examination  by  the  State 
authorities  of  State  banks  and  trust  companies,  although 
the  board  may  at  any  time  direct  the  holding  of  a  special 
examination  of  State  banks  and  trust  companies  that  are 
stockholders  in  any  Federal  reserve  bank.  The  power  of 
the  examiner  to  require  the  cooperation  of  banking  officials 
is  extended,  he  now  having  the  authority  to  make  a  thorough 
examination  of  all  of  the  affairs  of  the  bank,  to  adminis- 
ter oaths  and  to  examine  anv  of  the  officers  and  agents 


EFFECT  ON  COUNTRY  BANKS  351 

thereof  under  oath  when  he  deems  this  course  necessary. 
The  Federal  Reserve  Board  is  given  the  power,  upon  recom- 
mendation of  the  Comptroller  of  the  Currency,  to  fix  the 
salaries  of  all  bank  examiners.  The  expense  of  examination 
shall  be  assessed  by  the  Comptroller  upon  the  banks  exam- 
ined in  proportion  to  the  assets  and  resources  held  by  them 
on  the  dates  of  their  examination.  In  addition  to  the  exam- 
inations made  by  the  Comptroller  of  the  Currency,  every 
reserve  bank  may,  with  the  approval  of  the  Federal  reserve 
agent  or  of  the  Federal  Reserve  Board,  provide  for  the 
special  examination  of  the  member  banks  within  its  district. 
The  expense  of  such  examination  shall  be  borne  by  the  banks 
examined.  The  law  specifies  that  "such  examination  shall 
be  so  conducted  as  to  inform  the  Federal  reserve  bank  of  the 
condition  of  its  member  banks  and  of  the  lines  of  credit 
which  are  being  extended  by  them." 

The  amendment  to  the  National  Bank  Act  which  the  Pujo 
Committee  endeavored  to  have  Congress  authorize  at  the 
time  of  its  investigation,  by  which  Congress  should  have  the 
power  to  examine  the  affairs  of  the  banks  by  either  House 
thereof  or  by  any  committee  of  Congress  or  of  either  House, 
has  been  inserted  in  the  new  law. 

Modification  of  System  of  Fees. — The  old  system  of 
fees,  as  provided  in  Section  5240,  has  been  stricken  out,  the 
new  method  of  payment  being  not  a  flat  rate  but  one  which 
can  be  fixed  by  the  Comptroller  and  which  will  bear  a  proper 
relation  to  the  cost  of  the  examination. 

Section  22  of  the  Federal  Reserve  Act  prohibits  any  mem- 
ber bank  or  any  of  its  officers,  directors  or  employees  to  make 
any  loan  or  grant  any  gratuity  to  any  bank  examiner  under 
penalty  of  imprisonment  for  not  exceeding  one  year  or 
$5,000  fine,  in  addition  to  the  sum  loaned  or  granted,  or 
both.  Any  examiner  accepting  a  loan  or  gratuity  from  such 
a  source  shall  be  guilty  of  a  misdemeanor  and  liable  to  im- 
prisonment for  not  exceeding  one  year,  or  a  fine  of  not 
more  than  $5,000,  together  with  a  sum  equivalent  to  the 
loan  or  gratuity,  or  both,  and  shall  forever  thereafter  be 
disqualified  from  liolding  office  as  a  national  liank  examiner. 


35^       OPERATION  OF  THE  NEW  BANK  ACT 

No  officer,  director,  employee  or  attorney  of  a  member  bank 

shall  receive  any  fee  or  gift  in  connection  with  the  trans- 
action of  any  business  of  the  bank  other  than  the  usual 
salary  or  director's  fee  paid  for  ordinary  services  rendered. 
These  provisions  amending  Section  5240  are  not  to  take 
effect  until  sixty  days  after  the  passage  of  the  Act,  that  is  to 
say,  not  until  February  22,  1914. 

Stiffening  the  Law  Relating  to  Stockholders'  Liability. 
— In  addition,  the  much  sought  amendment  endeavoring  to 
fix  more  firmly  the  liability  of  the  stockholders  for  the 
debts  of  insolvent  national  banks  has  been  at  last  enacted. 
Section  23  of  the  Act  provides  as  follows: 

' '  The  stockholders  of  every  national  banking  association 
shall  be  held  individually  responsible  for  all  contracts,  debts, 
and  engagements  of  such  association,  each  to  the  amount  of 
his  stock  therein,  at  the  par  value  thereof  in  addition  to 
the  amount  invested  in  such  stock.  The  stockholders  in  any 
national  banking  association  who  shall  have  transferred  their 
shares  or  registered  the  transfer  thereof  within  sixty  days 
next  before  the  date  of  the  failure  of  such  association  to  meet 
its  obligations,  or  with  knowledge  of  such  impending  failure, 
shall  be  liable  to  the  same  extent  as  if  they  had  made  no  such 
transfer,  to  the  extent  that  the  subsequent  transferee  fails 
to  meet  such  liability;  but  this  provision  shall  not  be  con- 
strued to  affect  in  any  way  any  recourse  which  such  share- 
holders might  otherwise  have  against  those  in  whose  names 
such  shares  are  registered  at  the  time  of  such  failure. ' ' 

Authorization  of  Foreign  Branches. — A  privilege 
granted  to  national  banks,  which  will  be  appreciated  by  the 
large  institutions  in  our  big  cities,  is  the  right  to  establish 
foreign  branches  under  certain  conditions.  Only  banks 
having  a  capital  and  surplus  of  one  million  dollars  are  eli- 
gible to  this  privilege,  which  is  to  be  exercised  under  such 
rules  and  regulations  as  may  be  prescribed  by  the  Reserve 
Board.  Any  bank  desiring  this  privilege  shall  make  appli- 
cation specifying  its  name,  capital,  place  of  doing  business, 
and  the  amount  of  capital  set  aside  for  conducting  its  foreign 
business.     If  this  application  is  approved  by  the  Reserve 


EFFECT  ON  COUNTRY  BANKS  353 

Board,  the  bank  may  thereupon  establish  foreign  branches 
in  accordance  with  the  application.  Every  bank  estab- 
lishing foreign  branches  is  required  at  all  times  to  furnish 
information  concerning  the. condition  of  such  branches  to 
the  Comptroller  of  the  Currency  upon  demand.  The  Fed- 
eral Reserve  Board  possesses  the  power  to  make  special 
examinations  of  foreign  branches  at  any  time.  The  accounts 
of  the  foreign  branches  shall  be  conducted  independently  of 
the  accounts  of  other  foreign  branches  established  by  it  and 
of  its  home  office.  The  bank  shall,  at  the  end  of  the  fiscal 
year,  transfer  to  its  general  ledger  the  profit  or  loss  accru- 
ing at  each  branch,  as  a  separate  item. 


23 


CHAPTER  XXX 

The  Reserve  City  Banks  under  the  New  Law 

General  Advantages  to  Reserve  Banks. — If  it  is  true 
that  the  eoiintiy  banks  will  profit  under  the  new  system  and 
that  membership  will  be  a  decided  business  advantage  to 
them,  it  is  equally  true  in  the  case  of  the  reserve  city 
banks.  As  we  come  up  the  scale,  the  profitableness  of  mem- 
bership continues  to  be  evident,  all  classes  of  national 
institutions  sharing  in  the  benefits.  This  is  true  not  only 
as  regards  profits,  but  it  is  true  with  respect  to  collateral 
advantages.  The  danger  of  panics  or  other  business  dis- 
turbances crippling  or  ruining  a  bank  increases  with  the 
amount  of  bankers'  deposits  that  it  holds.  A  reseiwe 
city  institution  is  much  more  likely  to  be  ruined  than  a 
country  bank,  while  the  central  reserve  city  institution  is  the 
most  vulnerable  of  all.  The  only  difference  between  the  posi- 
tion of  the  three  classes  of  institutions  is  that  if  the  country 
bank  shuts  its  doors  it  is  ruined,  for  the  community  will 
never  have  confidence  in  it  again.  If  this  harsh  rule  had 
prevailed  with  reserve  city  and  central  reserve  city  banks, 
they  would  have  ceased  to  exist  after  many  of  the  six 
convulsions  which  have  shaken  the  financial  world  in  the  last 
fifty  years.  Suspension  of  cash  payments  by  the  central 
reserve  city  and  reserve  city  banks  during  crises  has  come 
to  be  recognized  as  a  customary  thing,  and  no  particular 
stigma  attaches  to  these  institutions  because  of  their  inabil- 
ity to  meet  their  obligations  at  such  times. 

Each  Bank  Will  Be  Safer. — While  the  reserve  city  and 
central  reserve  city  banlvs  have  been  able  to  weather  finan- 
cial storms  by  disregarding  their  obhgations  for  the  time 
being,  yet  such  a  course,  unless  generally  resorted  to,  is  not 
open  to  any  particular  institution.  A  general  panic  will 
354 


RESERVE  CITY  BAxNKS  UNDER  NEW  LAW  355 

bring  about  universal  suspension  and  no  bank  suffers. 
Where  the  drive  is  at  one,  or  at  a  few  institutions,  it  will 
ruin  them  if  they  suspend.  This  was  conclusively  proven 
in  the  case  of  the  Oriental  Bank  and  a  number  of  other  sol- 
vent institutions  wrecked  in  or  following  the  panic  of  1907. 
Every  reserve  city  or  central  reserve  city  bank  is  subject  to 
the  possibility  that  some  unfounded  rumor  or  unfortunate 
occurrence  will  cripple  or  ruin  it  because  it  can  not  suspend 
payments,  and  because  it  can  secure  the  cash  necessarj^  to 
meet  the  claims  of  its  frightened  depositors  only  by  the 
most  ruinous  sacrifices,  if  at  all. 

Suspensions  Should  Be  Unknown. — As  many  liankers 
have  phrased  it,  the  new  Federal  Reserve  Act  will  enable 
them  to  "sleep  better  at  night."  This  haunting  dread  of 
sudden  disaster  will  largely  vanish ;  for  if  the  reserve  city 
or  central  reserve  city  bank  has  a  large  proportion  of  its 
assets  invested  in  prime  paper,  eligible  for  rediscount,  it 
may  feel  secure  because  of  its  ability  to  go  to  the  Federal 
reserve  bank  and  convert  its  assets  into  cash  at  short  notice. 
The  repetition  of  such  scenes  as  disgraced  American  banking 
in  1907,  where  perfectly  solvent  institutions  which  had 
been  well  managed  were  wrecked  either  through  the  absence 
of  any  means  of  saving  them,  through  the  failure  of  coopera- 
tive effort  among  the  bankers  of  their  community,  or  through 
inexcusable  mismanagement  by  the  clearing  house,  should  be 
impossible  in  the  future.  If  the  Federal  Resen'e  Act  does 
nothing  more  than  this,  it  will  have  justified  its  existence  in 
so  far  as  reserve  city  and  central  reserve  city  banks  are 
concerned. 

Act  Forces  the  Hand  of  the  Reserve  City  Banks. — We 
have  already  seen  that  the  Federal  Reserve  Act  cleverly 
forces  the  hand  of  the  reserve  city  and  central  reserve  city 
bankers  by  requiring  them  to  accept  its  provisions  and  apply 
for  membership  in  the  Federal  resei've  banks  within  sixty 
days  from  the  signing  of  the  measure ;  that  is  to  say,  on  or 
before  Febniary  22,  1914.  Failure  to  do  so  will  render 
the  bank  liable,  at  the  discretion  of  the  organization  com- 


356       OPERATION  OF  THE  NEW  BANK  ACT 

mittee  or  the  Federal  Reserve  Board,  to  be  deprived  of  its 
privilege  of  acting  as  a  reserve  agent.  This  provision  prac- 
tically forces  the  reserve  city  and  central  reserve  city  banks 
into  the  system.  They  could  not  as  a  class  meet  their  obli- 
gations to  the  country  banks  if  the  letter  of  the  law  were 
strictly  applied,  owing  to  their  inability  to  convert  a  suffi- 
cient amount  of  resources  into  cash  within  the  time  specified, 
without  great  sacrifice  to  themselves  and  tremendous  loss  to 
the  business  community  which  they  serve.  For  any  reserve 
city  bank,  a  large  proportion  of  whose  deposits  are  the 
funds  of  other  banks,  to  consider  surrendering  its  charter 
and  failing  to  become  a  member  is  absurd.  For  this  reason, 
if  for  no  other,  it  is  practically  certain  that  all  reserve 
city  and  central  reserve  city  banks  will  become  member 
institutions. 

Relative  Profits  under  the  Old  and  New  Systems. — 
Following  the  same  plan  pursued  in  analyzing  the  effect  of 
the  law  upon  the  country  banks,  and  using  the  Comptroller's 
method  of  calculating  changes  in  profits,  let  us  see  what 
will  be  the  relative  profitableness  of  the  average  reserve  city 
institution  under  previous  conditions,  and  also  three  years 
after  the  Federal  Resei've  Act  has  been  put  into  operation : 

RESERVE  CITY  BANKS. 

Assuming  that  country  banks  finance  one-half  of  Federal  bank  payment  from  own 
vaults  and  call  on  reserve  city  and  central  reserve  city  banks  for  balance  in 
equal  proportions. 


Items  (for  an  average  bank). 


Net  demand  deposits. 
Net  time  deposits. . . . 
Total  deposits 


Reserves  in  own  vaults 

Reserves  with  reserve  agents 

Reserves  with  Federal  reserve  bank 
Total  reserve 


National  bank  notes  outstanding 

United  States  deposits 

Capital  stock  of  Federal  reserve  bank. 


Under  old 

system. 

After  three 
years. 

$5,631,000 

468,000 

$6,099,000 

$5,363,000 

468.000 

$5,831,000 

$762,400 
762,400 

$276,284 

552,566 

$1,524,800 

$828,850 

$522,200 
112,100 

$504,795 

42,900 

The  above  changes  would  have  following  effect  (reserve  city  banks,  free  funds) : 


RESERVE  CITY  BANKS  UNDER  NEW  LAW  357 


Upon  loanable  funds: 

Decrease  in  net  deposits 

Decrease    in    reserve,  less    5   per   cent 

redemption  fund 

Retirement  of  circulation  (1/30) 

Sale  of  bonds 

Withdrawal  of  United  States  deposits. . 
Purchase  of  Federal  reserve  stock 

Total 

Net  incr^se  in  free  funds 

Upon  income: 

Loss  on  profit  of  circulation  about  1.2 
per  cent 

Profit  on  balance  with  Federal  reserve 
bank  about  3  per  cent  on  $552,506..  . 

Loss  on  deposits  withdrawn  from  re- 
serve agents  2  per  cent  on  $702,400. . 

Dividends  on  stock  Federal  reserve  bank 

Total 

Net  gain  in  income 


Decrease. 


Increase. 


$268,000 


■  17,465 
'112,166 

42,900 

$669,840 
■  ■84.366 

$440,405 

$754,140 
313,735 

$208.86 



15,248.00 

$16,576.98 
2,574.00 

$15,456.86 

$19,150.98 
$3,694.12 

All  of  the  facts  upon  which  this  calculation  is  based,  such 
as  net  demand  deposits,  time  deposits,  bonds  deposited 
with  the  United  States,  etc.,  have  been  secured  by  dividing 
the  total  of  each  item  for  all  reserve  city  banks  in  the  United 
States  by  the  number  of  reserve  city  banks,  thus  giving  us 
the  average  condition  for  each  institution.  It  is  possible, 
of  course,  for  any  one  to  work  out  a  similar  computation  for 
any  individual  bank,  using  the  actual  figures  in  that  case. 

We  find  that  upon  this  basis  there  is  a  net  increase  in  free 
funds  available  for  investment  of  $313,735,  practically  all 
of  which  is  due  to  the  decrease  in  the  reserve  requirements 
under  the  new  law.  In  calculating  the  decrease  of  the  re- 
serve requirements,  account  has  been  taken  of  the  fact  that 
the  five  per  cent  redemption  fund  can  no  longer  be  included 
as  part  of  the  bank's  reserve.  The  method  followed  has 
been  to  take  the  net  decrease  in  reserve  as  between  the  con- 
ditions under  the  Nation;il  Bank  Act,  and  under  the  new  Act 
three  years  after  the  establishment  of  the  new  reserve  sys- 
tem, subtracting  therefrom  the  amount  of  the  five  per  cent 
fund,  just  as  though  it  had  boon  inoludAd  as  an  increased 
item  of  investment  upon  which  no  income  would  be  derived. 

According  to  Iho  mctliod  ciiiploycd  ])y  the  Tomptroller, 


358       OPERATION  OF  THE  NEW  BANK  ACT 

the  net  increase  in  the  earnings  of  the  average  reserve  city 
bank  would  be  $3,694.12  a  year.  This  amount  is  predicated 
almost  entirely  upon  the  assumption  that  the  balance  on 
deposit  with  the  Federal  reserve  bank  will  earn  about  three 
per  cent.  We  have  already  considered  the  question  as  to 
whether  this  is  a  fair  assumption.  Experience  alone  can 
show  whether  the  balances  will  be  as  profitable  as  this.  An 
accurate  estimate  would  apparently  have  to  take  into  account 
the  balances  remaining  on  deposit  with  the  central  reserve 
agents  after  the  new  reserve  requirements  have  been  com- 
pletely adopted.  We  have  seen,  however,  that  in  all  probabil- 
ity these  reserves  will  be  largely,  if  not  entirely,  exhausted  in 
the  process  of  meeting  the  reserve  requirements  of  the  Fed- 
eral Reserve  Act.  Therefore  this  additional  element  of  profit 
is  so  speculative  that  no  calculation  can  be  based  upon  it. 
Indeed,  it  is  unlikely  that  any  considerable  amount  of 
reserve  will  remain  with  the  central  reserve  agents  after  the 
new  law  is  in  full  force  and  effect. 


CHAPTER  XXXI 

Effect  of  the  System  upon  New  York  and  Other  Cen- 
tral Reserve  Cities 

Difficulty  of  Accurate  Estimates. — Anyone  who  has  re- 
viewed the  calculations  in  the  chapter  on  "The  Shifting  of 
Reserves  in  Central  Resei've  Cities"  will  realize  how  difficult, 
if  not  impossible,  it  is  to  make  an  adequate  estimate  of  the 
effect  which  the  new  law  will  have  upon  the  profits  of  central 
reserve  city  banks.  There  are  so  many  elements  of  uncer- 
tainty over  which  these  institutions  have  no  control,  which 
must  be  considered,  that  it  is  almost,  if  not  quite  impossible 
to  reach  any  intelligent  conclusion  as  to  the  final  outcome. 
The  calculations  which  follow  are  intended  by  the  authors 
not  as  a  representation  of  what  will,  in  their  judgment, 
occur,  for  they  do  not  care  to  venture  any  specific  predic- 
tion ;  but  are  inserted  only  as  generally  illustrative  of  the 
method  by  which,  if  the  facts  could  be  known,  the  effects  of 
the  changes  upon  the  reserve  city  banks  could  be  estimated. 

Calculations  Based  on  the  Average  Institution. — As 
the  basis  of  our  comparison  we  have  taken  the  assumption 
which  we  heretofore  found  to  be  the  most  probable  during 
the  next  few  years,  viz. :  the  loss  of  only  a  part  of  the 
reserve  deposits  now  held  by  the  central  resen-e  city  banks. 
An  attempt  has  been  made,  as  heretofore,  to  reach  the 
average  amount  of  the  several  important  items  held  by  each 
institution,  by  taking  the  total  of  each  for  all  of  the  central 
reserve  city  banks  of  the  country,  and  dividing  it  by  the 
number  of  central  reserve  city  banks.  Upon  this  basis,  the 
comparative  items,  subject  to  change  after  the  reserve  re- 
quirements have  been  finally  established,  would  be  as 
follows : 

359 


360       OPERATION  OF  THE  NEW  BANK  ACT 


CENTRAL  RESERVE  CITY  BANKS 

(Average  of  52  banks.) 

AssuininR  country  banks  withdraw  one-rjuarter  of  Federal  bank  payments  from 
central  reserve  agents,  and  that  reserve  city  banks  finance  themselves  as  far  as 
possible.    (Assumption  No.  2.) 


Items. 

Under  old 
system. 

After  three 
years. 

$29,336,000 

299.000 

$29,635,000 

$24,817,000 

299,000 

$25,116,000 

Reserves  in  own  vaults 

Reserves  with  Federal  bank 

$7,408,750 

$1,494,004 
2,988,006 

$7,408,750 

$1,480,345 
229,700 

$4,482,010 

National  bank  notes  outstanding 

$1,431,000 

200,500 

Effect  of  Act  upon  the  Bank's  Income. — Upon  the 
basis  of  these  assumptions,  the  relative  increase  and  decrease 
of  loanable  funds,  by  items,  and  the  effect  which  these 
changes  would  have  upon  the  bank's  income  would  be  as 
follows : 

The  above  changes  would  have  the  following  effect  (central  reserve  city  banks): 


Items. 


Decrease. 


Increase. 


Upon  loanable  funds: 

Decrease  in  net  deposits '         $4,519,000 

Decrease   in    reserve    (less  5  per  cent 

redemption  fund) I  

Retirement  of  circulation  (1/30) 

Sale  of  United  States  bonds 

United  States  deposits  withdrawn 

Purchase  of  Federal  reserve,  stock. .  . . 

Total 

Net  decrease 

Upon  income: 

Loss  of  profit  on  circulation  about  1.2 

per  cent 

Profit   on    balance    with    reserve   bank 

about  3  per  cent I  

Dividend  on  Federal  reserve  stock  6  per 

cent J  

Total ;  $592.14 

Net  gain  in  income '  


49,345 


229,700 
200,478 


$4,998,523 
1,992,333 


$592.14 


$2,855,190 

isi'.eoo 


$3,006,190 


§149.640.18 
12,030.00 


$161,670.18 
161,078.04 


EFFECT  ON  CENTRAL  RESERVE  CITIES    361 

Central  Reserve  City  Banks  Fare  Well. — It  is  not 
believed  that  any  general  comment  is  necessary,  since  the 
method  followed  is  identical  with  that  pursued  in  the  pre- 
ceding studies  concerning  the  country  and  reserve  city 
banks.  As  no  new  problems  are  introduced,  the  assumptions 
are  the  same  throughout.  Upon  the  basis  of  these  assump- 
tions it  will  be  seen  that  the  net  increase  in  the  profits  of  the 
average  central  reserve  city  bank  will  be  approximately 
$161,078.04.  Upon  the  basis  of  an  average  capitalization  of 
approximately  $3,512,500  per  bank,  this  sum  would  repre- 
sent an  additional  return  of  approximately  4.6  per  cent.  Be- 
cause of  this  excellent  showing  for  the  central  reserve  city 
banks  there  has  arisen  a  charge,  frequently  heard  during 
the  hearings  on  the  bill,  that  the  law  was  unduly  favorable 
to  these  institutions,  as  contrasted  with  its  benefits  to  the 
other  classes  of  banks. 

Historically,  the  great  majority  of  our  difficulties  have 
arisen  because  of  the  inability  of  the  central  reserve  city 
banks  to  met  the  requirements  placed  upon  them  by  the 
National  Bank  Act  and  by  actual  conditions.  The  break- 
down has  always  come  with  that  class  of  institution,  disaster 
spreading  to  the  reserve  city  and  country  banks.  Will  these 
institutions  cease  to  be  the  weak  spot  in  our  banking  system  ? 
If  so,  most  of  the  banking  difficulties  which  have  beset  this 
country  in  the  last  fifty  years  will  disappear. 

The  withdrawal  of  reserve  accounts  from  the  central 
resei-ve  city  banks  will  be  a  severe  experience.  Some  insti- 
tutions may  be  reduced  in  size,  power  and  prestige  will  cor- 
respondingly diminish,  officers  will  be  released  and  the  ser- 
vices of  many  dorks  dispensed  with.  It  is  inevitable,  under 
such  conditions,  that  much  complaint  will  be  heard  against 
the  unfairness  and  short-sightedness  of  the  Act.  As  a  matter 
of  fact,  there  is  no  doubt  that  any  banking  law  which  would 
perpetuate  the  highly  unscientific  and  dangerous  system  of 
the  deposit  of  resoi'ves  in  institutions  unfitted  to  handle 
them,  and  conducting  thoir  operations  in  direct  violation  of 
the  methods  followed  in  every  other  country  of  the  world, 
is  foredoomed  to  failuro. 


362       OPERATION  OF  THE  NEW  BANK  ACT 

Greatest  Achievement  Has  Been  to  Reform  the  Re- 
serve Situation. — The  greatest  achievement  of  President 
Wilson  and  his  coworkers  in  the  House  and  Senate  was  in 
overcoming  the  determined  opposition  of  the  central  reserve 
and  resei-ve  city  bankers  to  this  part  of  the  law.  The 
enactment  of  this  one  feature  stamps  the  Act  as  incompara- 
bly better  than  the  Aldrich  bill,  and  as  one  much  better  than 
the  country  had  any  reasonable  expectation  of  securing. 
As  time  passes  and  the  vista  becomes  more  perfect,  the 
extent  of  this  great  victory  will  be  more  apparent. 

But  even  though  the  present  system  is  inefficient,  will 
the  new  one  be  any  better  and  will  it  serve  the  needs  of 
business  as  well,  or  more  perfectly  ?  Upon  the  answer  to  tliis 
question  depends  the  nation 's  verdict.  Little  can  be  said  in 
defence  of  what  has  been.  As  to  the  record  which  time  will 
write,  nothing  definite  can  now  be  known. 

The  Most  Serious  Defect  in  the  Act. — It  is  hoped  by 
the  supporters  of  the  Federal  Reserve  Act  that  the  unnatural 
and  illogical  concentration  of  money  in  New  York  City, 
which  has  been  induced  by  the  pajonent  of  two  per  cent 
interest  on  bankers'  deposits,  may  be  discontinued.  The 
ability  of  the  New  York  banks  to  loan  this  money  upon 
stock  exchange  collateral  at  call  and  on  time  has  been 
responsible  for  this  condition.  By  taking  the  greater  part 
of  the  "country  money"  out  of  New  York  City,  this  con- 
dition will  largely  disappear;  and,  as  we  have  seen,  the 
New  York  banks  will  in  addition  probably  curtail  their  loans 
or  investments  in  commercial  paper  bought  from  note 
brokers,  to  furnish,  in  whole  or  in  part,  the  money  which 
they  must  refund.  The  successful  readjustment  of  the 
reserves  of  the  country  is  determined  to  a  large  degree  by 
the  willingness  of  the  banks  in  our  reserve  cities,  and  of  our 
country  banks,  to  purchase  prime  commercial  paper  with 
the  funds  thus  recalled. 

The  great  defect  in  the  Federal  Reserve  Act  is  the  inabil- 
ity of  the  Federal  reserve  banks  to  loan  directly  on  the 
market,  or  to  invest  in  commercial  paper  offered  to  them 
by  note  brokers  or  by  borrowers.    Such  a  power  is  possessed 


EFFECT  ON  CENTRAL  RESERVE  CITIES    3G3 

by  every  central  bank  in  the  world,  and  has  been  found  of 
great  value  to  those  institutions.  It  will  be  very  difficult  to 
convince  a  reserve  city  or  a  countiy  banker  that  he  should 
buy  Armour  &  Company  or  John  Wanamaker  paper,  for 
example,  simply  because  the  central  reserve  city  banker  can 
no  longer  purchase  it,  due  to  the  fact  that  it  is  necessary  for 
him  to  curtail  his  loans  to  raise  money  to  refund  bankers' 
deposits.  It  will  be  peculiarly  difficult  to  convince  these 
bankers  that  they  should  make  larger  investments  in  com- 
mercial paper,  when  to  do  so  will  require  them  to  rediscount 
in  order  to  procure  the  necessary  funds. 

The  Vital  Problem  before  the  Country. — The  final 
result  of  the  Federal  Reserve  Act  will  be  to  take  between 
$420,000,000  and  $672,000,000  of  loanable  funds  out  of  their 
present  channels,  and  sequester  them  in  the  vaults  of  the 
eight  to  twelve  Federal  reserve  banks.  So  far  as  the  citizens 
of  this  country  are  concerned,  as  has  been  elsewhere  pointed 
out,  this  money  can  get  back  into  the  channels  of  trade  only 
through  rediscounting  by  member  banks,  or  by  the  purchase 
of  domestic  or  foreign  drafts  on  the  open  market.  Every 
merchant  realizes  that  the  draft  is  an  unpopular  method  of 
financing  business  in  this  country.  To  be  drawn  upon  is, 
in  many  sections,  a  sign  of  weakness,  and  betokens  the 
failure  of  the  debtor  to  pay  his  debt  when  it  becomes  due. 
The  great  majority  of  this  capital  can  be  placed  at  the 
service  of  our  banks  only  through  rediscounts. 

We  have  seen  that  a  large  proportion  of  the  banking  fra- 
ternity has  a  decided  opinion  against  rediscounting.  They 
hold  it  to  be  bad  banking.  Will  it  be  possible  completely  to 
change  their  opinions  and  to  make  rediscounting  popular  in 
the  space  of  a  few  months?  It  can  readily  be  seen  that 
the  answer  to  this  question  determines  to  a  large  degree 
the  success  of  the  new  Act.  Nothing  more  clearly  demon- 
strates the  power  of  the  banks  of  this  countn^'  to  make  the 
Act  a  failure,  and  to  do  so  unconsciously  and  without  pre- 
meditation. We  have  seen  that,  to  a  considerable  degree, 
rediscounts  will  be  necessary,  and  it  is  to  be  hoped  that 
the  example  of  the  big  central  reserve  city  banks  wiU  prove 


364       OPERATION  OF  THE  NEW  BANK  ACT 

efficacious  and  that  a  reasonable  amount  of  rediscounting 
will  occur  in  order  to  liberate  the  funds  which  are  tied  up 
in  the  vaults  of  the  Federal  reserve  banks. 

Universal  Interest  in  the  Effect  upon  New  York  City. 
— The  effect  of  the  Federal  Reserve  Act  upon  New  York 
City  will  be  watched  with  greater  interest  than  will  its  effect 
in  any  other  part  of  the  country,  except  in  the  observer's 
own  localit}'.  All  eyes  will  be  upon  the  nation 's  metropolis , 
some  to  see  whether  it  will  accomplish  the  boasted  end  of 
destroying  speculation  on  the  New  York  Stock  Exchange, 
which  has  unsettled  values  and  tied  up  a  considerable 
proportion  of  the  resources  of  the  country  in  the  worst  class 
of  operation.  Some  will  look  with  concern  lest  the  new  law, 
by  suddenly  depriving  stock  and  investment  markets  of 
funds,  will  create  disorganization,  palsying  new  construction 
which  must  be  financed  through  the  sale  of  securities,  and 
unsettling  the  value  of  collateral  upon  which  thousands  of 
business  men  have  negotiated  loans  to  carry  on  their  enter- 
prises. Others  will  be  interested  to  see  whether  New  York 's 
power  and  prestige  will  be  diverted  in  part  to  other  centers, 
with  the  localization  of  funds  in  these  new  districts.  Every 
one  will  be  interested  to  know  whether  it  will  destroy  or  im- 
pair the  efficacy  of  the  so-called  "Money  Trust,"  which  is 
founded  primarily  upon  the  control  of  a  comparatively 
small  number  of  banking  institutions  that  hold  these 
bankers'  deposits  from  the  other  sections  of  the  country. 

Will  Cheap  Money  for  Stock  Exchange  Uses  be  Avail- 
able?— It  is  impossible  to  answer  any  of  these  questions 
authoritatively.  It  would  appear  that  the  day  of  exceed- 
ingly cheap  money  for  stock  exchange  uses  is  past.  Without 
a  law  which  renders  an  enormous  amount  of  money  idle, 
thereby  enabling  the  New  York  banks  to  attract  it  to  New 
York  with  a  two  per  cent  interest  rate,  it  will  be  impossible 
for  the  New  York  institutions  to  offer  call  money  at  an  aver- 
age rate  of  about  two  and  one-half  per  cent,  as  has  been  the 
case  within  the  last  ten  years. 

The  stock  speculator  and  the  investment  banker  who  are 
carrying  securities  until  such  time  as  they  can  dispose  of 


EFFECT  ON  CENTRAL  RESERVE  CITIES    365 

them,  will  have  to  pay  rates  of  interest  approximatiDg  those 
which  have  prevailed  abroad  and  which  are  determined  with 
reference  to  the  rates  paid  by  commercial  borrowers.  Call 
loans  will  probably  be  offered  at  attractive  rates  in  limited 
amounts,  but  the  great  majority  of  money  will  probably  be 
secured  at  interest  rates  of  four  per  cent  or  over.  Certain 
New  York  bankers  expressed  the  opinion  before  the  Con- 
gressional committees  that  it  would  be  impossible  to  deprive 
New  York  of  funds  for  stock  exchange  uses,  so  long  as  the 
borrowers  were  willing  to  pay  a  good  rate  of  interest.  A 
comparatively  small  number  of  New  York  City  banks  now 
have  funds  of  15,000  other  banks.  These  gentlemen  pre- 
dicted that  these  institutions  could  induce  the  out-of-town 
banks  to  rediscount  commercial  paper  at,  say  three  or  four 
per  cent,  which  might  then  be  the  rate,  forwarding  the 
proceeds  to  New  York  to  be  loaned  out  upon  stock  exchange 
collateral  at,  say  five  or  six  per  cent.  The  profits  to  be 
derived  from  this  transaction  are,  in  their  opinion,  so  obvious 
as  to  tempt  many  bankers.  Such  a  practice,  if  it  should 
develop  to  any  large  degree,  would  be  unfortunate,  for  by 
indirection  it  would  work  an  evasion  of  the  plain  intent 
of  the  Act. 

Ways  to  Check  Drain  of  Money  to  Wall  Street. — It 
would  be  very  difficult  for  the  Federal  Reserve  Board  to 
locate  the  extent  to  which  this  practice  was  being  carried  on. 
It  might  assume  that  banks  were  borrowing  to  finance  local 
needs  when,  as  a  matter  of  fact,  the  money  was  being  sent 
to  New  York.  An  energetic  search  conducted  by  the  exam- 
iners of  the  Federal  reserve  bank  or  of  the  board  would,  of 
course,  indicate  the  extent  of  the  practice  and  the  institu- 
tions engaging  in  it.  Once  this  was  discovered,  it  would  be 
possible  to  apply  corrective  measures,  concerning  the  efficacy 
of  which  there  can  be  no  doubt.  The  offending  bank  would 
be  informed  that  it  must  call  its  loans  or  be  refused  further 
accommodation  by  the  Federal  reserve  bank,  while  the  board 
could  effect  a  change  by  advancing  the  rate  of  discount  for 
the  region  in  which  offending  member  banks  were  situated. 
The  latter  course,  however,  would  be  unfortunate  because,  in 


366       OPERATION  OF  THE  NEW  BANK  ACT 

stamping  out  the  surreptitious  sending  of  money  to  New 
York,  legitimate  business  would  be  penalized  and  business 
conditions  unsettled. 

Looked  at  from  another  stand-point,  however,  the  matter 
does  not  seem  to  be  as  serious  as  might  appear  on  the  sur- 
face. There  is  abundant  testimony  to  support  the  statement 
that  it  is  very  difficult  to  carry  on  profitable  speculative 
operations  on  a  large  scale  with  high  interest  rates ;  but  so 
long  as  the  money  was  not  being  used  to  conduct  feverish  and 
undesirable  speculation,  from  a  national  stand-point,  there 
is  no  reason  why  New  York  should  not  be  allowed  to 
attract  it. 

Methods  of  financing  stock  exchange  speculation  may  be 
radically  altered.  Already  there  is  talk  of  going  over  to  the 
English  system  of  fortnightly  settlements,  which  would 
greatly  decrease  the  amount  of  money  necessary  to  finance 
stock  exchange  operations.  This,  however,  is  but  a  sugges- 
tion ;  and  it  is  veiy  possible  that  public  opinion,  or  even 
restrictive  legislation,  will  interfere  with  such  a  plan,  even 
though  it  may  be  under  serious  consideration. 

Has  New  York  Reached  Her  Zenith? — Looking  at  the 
matter  from  the  stand-point  of  the  next  generation,  there  is 
much  evidence  to  support  the  contention  that  Ncav  York's 
overwhelming  supremacy  in  the  financial  affairs  of  the 
United  States  has  run  its  couree ;  and  that,  by  comparison 
with  the  other  great  cities  of  the  country,  she  will  gradually 
decline,  not  necessarily  through  any  diminution  in  the  actual 
amount  of  her  business,  but  because  of  the  verj^  rapid  growth 
of  other  centers.  Chicago,  in  the  last  few  years,  has  been 
forging  ahead  at  a  tremendous  pace  as  an  investment  bank- 
ing center.  If  the  same  relative  progress  is  maintained  by 
the  two  cities,  the  time  will  come,  and  that  within  a  very 
few  years,  when  she  will  rival  New  York  a§  a  center  for  this 
business.  The  rapid  growth  in  the  material  wealth  of  the 
West,  the  increasing  appreciation  of  the  advantages  of  secu- 
rity investments,  and  many  other  factors  are  responsible 
for  the  imposing  progress  of  Chicago. 

The  Rise  of  Other  Cities. — The  same  development  which 


EFFECT  ON  CENTRAL  RESERVE  CITIES    367 

has  occurred  in  Chicago  has  been  duplicated  on  a  smaller 
scale  in  many  other  of  our  larger  cities.  Even  under  the 
old  banking  sj'stem,  New  York  was  relatively  losing  ground. 
With  the  segregation  of  the  banking  assets  of  the  country 
into  eight  to  twelve  groups,  a  much  larger  degree  of  local 
banking  independence  will  occur.  There  is  really  no  im- 
pelling reason  why  the  reserves  of  the  ^liddle  AVest,  or  of 
the  Southwest,  or  of  any  other  section  of  the  country 
should  be  sent  to  New  York,  unless  it  be  frankly  for  em- 
ployment in  stock  exchange  operations.  It  is  possible,  as  a 
banking  problem,  to  develop  a  method  of  selling  commercial 
paper  in  Chicago  or  St.  Louis  or  San  Francisco  or  New 
Orleans  as  readily  as  it  can  be  sold  in  New  York  City.  With 
no  defenders  of  the  use  of  the  nation's  reserve  in  stock 
exchange  speculation,  therefore,  there  remains  no  reason 
why  New  York  and,  to  a  lesser  extent,  Chicago,  should  be 
given  this  unusual  monopoly  advantage. 

New  York  will  for  many  years  to  come  be  the  commercial 
center  of  the  United  States,  because  it  is  the  point  through 
which  the  greater  proportion  of  our  imports  and  exports 
passes.  She  will  incidentally  be  the  leading  center  of  all  for- 
eign exchange  operations.  Happily  the  day  of  the  concen- 
tration of  the  banking  reserves  of  the  country  in  the  hands 
of  ten  or  more  institutions  of  one  city  is  almost  over. 


CHAPTER  XXXII 

State  Banks  and  the  New  Law 

Advantages  of  National  Banks. — Having  reviewed  the 
probable  effect  of  the  new  law  upon  the  various  classes  of 
national  banks,  let  us  investigate  its  probable  influence  upon 
the  State  banks  and  trust  companies.  In  the  past,  tlie 
national  banks  have  had  several  advantages  over  the  State 
institutions.  First  among  these  has  been  their  right  of 
note  issue.  In  a  previous  chapter  we  have  pointed  out 
that  the  advantages  of  this  are  by  no  means  great  and  that 
many  of  them  are  indirect.  It  should  be  borne  in  mind  that 
such  advantages  as  have  existed  might  be  turned  into  a  dis- 
tinct loss  if  the  price  of  the  bonds  purchased  to  secure  the 
notes  should  fall  to  any  considerable  extent.  Such  a  fall 
occurred  during  the  year  1913,  and  many  of  the  banks  have 
been  compelled  to  write  off  the  premium  which  they  paid 
for  these  securities  and  formerly  carried  as  an  asset  on 
their  books. 

Acting  as  Reserve  Agents. — Another  advantage  has 
been  that  the  national  banks  have  been  allowed  to  act  as 
reserve  agents  for  other  banks.  This  applies  especially 
to  those  institutions  located  in  reserve  and  central  reserve 
cities.  The  country  banks  have  been  allowed  to  deposit  a 
part  of  their  reserves  with  the  reserve  or  central  reserve 
city  banks,  and  the  reserve  city  banks  have  deposited  a  part 
of  their  reserves  with  the  central  reserve  city  institutions. 
This  privilege  has  also  been  extended,  by  the  laws  of  vari- 
ous States,  in  such  way  as  to  be  of  great  value  to  the 
national  banks.  Thus  many  of  the  States  authorize  the 
State  institutions  to  keep  a  part  of  their  reserve  with  other 
State  institutions,  approved  by  the  State  banking  com- 
missioner as  reserve  agents,  or  with  national  banks  in 
reserve  and  central  reserve  cities  that  have  been  approved 
for  such  purposes  by  the  Comptroller  of  the  Currency  and 

368 


STATE  BANKS  AND  THE  NEW  LAW         369 

the  State  Banking  Conunissiouer.  Thus  there  have  come 
into  the  vaults  of  the  national  banks  in  the  great  cities 
large  deposits  from  the  smaller  iastitutions  on  which  they 
pay  interest,  ordinarily  at  the  rate  of  two  per  cent  per 
annum.  They  have  been  able  to  lend  these  funds  in  the 
open  market  at  whatever  rates  were  current. 

That  this  privilege  has  been  valuable  is  shown  by  tlie 
eagerness  among  many  of  the  national  banks  to  secure  these 
deposits.  A  large  number  have  sent  representatives  through 
the  country  to  solicit  such  accounts  and  some  of  the  larger 
institutions  have  secured  thousands.  It  is  only  fair, 
however,  to  point  out  that  the  value  of  this  right  to  act  as 
reserve  agents  is  somewhat  qualified  by  two  factors.  In 
the  first  place  the  resei*ves  kept  in  the  large  cities  by  the 
smaller  institutions  are  usually  cut  down  at  the  very  time 
when  conditions  in  the  money  market  are  most  favorable  to 
the  lender  and  kept  high  when  interest  rates  are  low.  This 
merely  qualifies  the  profitableness  of  this  business  and 
not  imply  that  it  is  not,  on  the  whole,  very  remunerative. 
The  second  feature  is  the  fact  that  by  a  sort  of  unwritten 
law  the  city  banks  that  hold  these  reserves  must  lend  to 
their  country  bank  depositors  when  requested  to  do  so.  It 
is  often  alleged  that  this  is  not  a  disadvantage  to  the  city 
bank,  since  it  is  usually  in  a  position  to  exact  a  high  interest 
rate  when  it  grants  the  loan. 

Depositaries  of  the  Federal  Government. — A  third  ad- 
vantage possessed  by  the  national  l)anks  has  been  their 
right  under  the  Federal  law  to  act  as  depositaries  for  gov- 
ernment funds.  Upon  government  deposits  they  are  re- 
quired by  law  to  pay  a  rate  of  interest  not  less  than  one 
per  cent  per  annum,  and  at  present  the  Secretary  of  the 
Treasury  is  requiring  them  to  pay  two  per  cent.  They  are 
also  required  to  place  with  the  Treasurer  at  Washington 
bonds  to  secure  the  funds  deposited  with  them.  The  loss 
that  has  occasionally  been  suffennl  by  the  national  banks 
through  a  decline  in  the  value  of  the  bonds  deposited  to 
secure  circulation  has  also  to  be  considered,  since  govern- 
ment bonds  have  been  and  are  still  largely  used  for  this 

24 


370       OPERATION  OF  THE  NEW  BANK  ACT 

purpose.  Of  the  $110,886,611  par  value  bonds  held  on 
January  7,  1914,  to  secure  deposits  of  public  money  with 
the  national  banks  over  one-half  or  $58,260,811  were  State, 
county,  city  and  other  securities.  The  balance  were  bonds 
of  the  United  States  government  and  of  its  dependencies. 
A  decline  in  an}^  of  these  securities  would  mean  a  loss  to 
the  banks  that  had  placed  them  in  trust,  and  such  loss 
has  been  especially  noticeable  on  the  United  States  two 
per  cent  bonds  which  are  held  in  large  amounts  for  this 
purpose.  Although  it  is  not  always  the  case  that  there 
is  a  large  profit  to  be  derived  from  receiving  these  govern- 
ment deposits,  there  is  a  certain  amount  of  prestige  that 
attaches  to  a  government  depositary,  and  this  doubtless 
compensates  for  any  disadvantages. 

The  Name  Gives  Prestige. — A  final  advantage  pos- 
sessed by  the  national  banks  has  been  that  a  considerable 
amount  of  sentiment  attaches  to  the  name  itself.  It  is  often 
the  case  that  promoters  of  a  new  bank  determine  to  charter 
the  institution  under  Federal  laws  because  the  name 
"National  Bank"  carries  weight  with  many  people  who 
fancy  that  it  is  entirely  safe  in  its  operations.  Even  per- 
sons who  are  thoughtful  consider  that  the  more  strict  su- 
pervision and  careful  examinations  conducted  by  the  Fed- 
eral officials  make  the  national  banks  more  reliable.  Thus 
the  name  itself  has  an  attraction,  and  doubtless  many  in- 
stitutions now  incorporated  as  national  banks  would  hesi- 
tate to  lose  the  advantage  that  there  may  be  in  the  name 
itself. 

Advantages  Possessed  by  State  Banks. — Turning 
from  the  advantages  possessed  by  the  national  banks  to 
those  attaching  to  State  institutions,  we  find  that  they  are 
numerous  and  in  some  cases  of  great  importance.  First  to 
be  noticed  is  that,  with  the  exceptions  already  mentioned. 
a  State  bank  may  do  practically  everything  that  is  done 
by  a  national  bank.  Some  of  them  may  act  as  reserve 
agents  for  other  State  institutions  and  many  of  them,  of 
course,  receive  deposits  of  State  and  municipal  funds,  al- 
though they  do  not  receive  Federal  deposits.     A  second 


STATE  BANKS  AND  THE  NEW  LAW         371 

advantage  is  their  right,  in  mauy  instances,  to  lend  on  real 
estate  security.  The  national  bank  act,  while  not  specific- 
ally denying  to  national  banks  the  right  to  lend  on  real 
estate,  forbids  their  owning  it  and,  by  specifying  only  the 
right  to  lend  on  personal  property,  by  implication  denies 
to  them  the  right  to  lend  on  real  property.  The  law  gov- 
erning State  institutions  varies  in  this  particular.  The 
majority  of  States  do  not  forbid  such  loans.  A  large 
number  of  them  limit  the  right  to  own  real  estate,  and  loans 
thereon  are  restricted  in  California,  IMichigan,  ^Minnesota, 
New  York,  North  Dakota,  Ohio,  Oklahoma,  Pennsylvania, 
South  Carolina,  Texas  and  Wisconsin.  Even  in  these 
States  the  chief  limitations  are  to  first  liens  or  to  a  limited 
percentage  of  the  capitalization  of  the  bank  or  to  a  fixed 
percentage  of  the  value  of  the  land. 

Investments  not  so  Closely  Limited. — A  third  ad- 
vantage of  State  incorporation  has  been  that  such  banks 
are  usually  allowed  to  invest  their  funds  in  stocks  and 
bonds.  The  right  of  national  banks  to  purchase  bonds  is 
by  no  means  clear,  but  has  been  upheld  as  the  purchase  of 
promissory  notes,  and  hence  similar  to  the  ordinary'  trans- 
action of  discounting  a  note.  Investments  in  stocks,  on 
the  other  hand,  are  clearly  illegal  for  national  banks.  Such 
investment  is  not  authorized  directly  or  indirectly  by  the 
national  bank  act  and  has  been  repeatedly  denied  by  the 
courts,  which  have  held  that  such  purchase  is  not  author- 
ized and  would  bo  equivalent  to  entering  upon  another  line 
of  business  than  that  for  which  the  charter  was  granted. 
State  banks  are  not  so  closely  limited. 

Still  another  advantage  possessed  by  the  State  banks 
has  been  the  right  to  act  in  a  fiduciary  capacity.  This  ap- 
plies primarily  to  trust  companies,  but  inasmuch  as  it  is 
easy,  especially  in  the  large  cities,  for  an  institution  to 
incorporate  as  a  trust  company  and  still  give  a  Inrgo  part 
of  its  time  and  attention  to  ordinnrv  commercial  banking, 
there  is  no  reason  why  a  State  institution,  which  so  de- 
fdres,  can  not  engage  in  this  business. 

Differences  in  Reserve  Requirements. — There  has  here- 


372       OPERATION  OF  THE  NEW  BANK  ACT 

tofore  been  an  advantage  to  many  State  institutions  in  the 
lower  reserve  requirements  imposed  by  the  State  laws.  In 
many  eases  a  smaller  amount  is  demanded  than  in  the  law 
for  national  banks,  the  ordinary  requirement  being  fifteen 
per  cent,  although  in  some  cases  it  is  twenty  or  twenty-five. 
No  matter  what  criticism  may  be  made  as  to  the  wisdom 
of  the  State  laws,  this  lowered  requirement  is  often  an 
advantage.  Even  though  the  judgment  of  the  State  bank 
may  dictate  a  larger  reserve  than  the  required  minimum 
it  may,  upon  occasion,  fall  below  its  own  self-imposed 
standard  and  still  not  break  the  law.  Of  course,  in  most 
cases  there  is  little  attempt  to  keep  more  than  the  legal 
minimum,  and  even  where  the  reserve  requirements  are 
nominally  high  there  are  a  good  many  qualifications  which 
lessen  their  severity.  Thus  in  Connecticut,  of  the  fifteen 
per  cent  required,  four-fifteenths  must  be  in  cash,  while 
eleven-fifteenths  may  be  in  deposits  with  other  institutions, 
or  one-fifth  may  be  in  securities.  The  eleven-fifteenths  may 
thus  be  divided  between  deposits  and  securities  or  all  be  in 
the  form  of  deposits  with  other  banks. 

National  Bank  Notes  in  Reserves. — A  final  advantage 
possessed  by  the  State  banks  is  their  right  to  use  national 
bank  notes  as  reserves.  National  banks  are  not  allowed  to 
count  in  their  reserves  either  their  own  notes  or  those  of 
other  national  banks.  The  State  laws  permit  the  use  of 
these  notes.  The  result  has  been  the  growth  of  the  prac- 
tice already  referred  to  of  the  national  banks  exchanging 
their  notes  with  State  banks  for  lawful  money.  It  has, 
also,  led  to  the  practice  of  the  same  group  of  men  who  are 
directors  and  officers  of  national  banks  organizing  State 
institutions  under  the  same  management.  This  close  union 
of  two  separate  corporations  having  practically  the  same 
officers  and  directors,  allows  the  one  group  of  men  to  engage 
in  different  lines  of  banking  and  secure  the  combined  ad- 
vantages of  the  Federal  and  State  laws.  Thus  a  national 
bank,  closely  associated  with  a  State  bank  and  trust  com- 
pany, may  issue  notes  and  engage  in  commercial  banking. 
The  associated  State  institution  will  handle  the  trust  busi- 


STATE  BANKS  AND  THE  NEW  LAW         373 

ness,  own  and  lend  on  real  estate  within  the  limits  of  the 
State  law,  and  readily  deliver  from  time  to  time  any  law- 
ful money  that  comes  into  its  possession,  to  the  national 
bank,  receiving  in  return  national  bank  notes  which  may 
be  used  as  a  part  of  its  reserve. 

Effects  of  the  New  Legislation. — Having  thus  sum- 
marized the  advantages  under  the  former  law  of  the  two 
classes  of  institutions,  we  are  ready  to  examine  the  actual 
and  relative  effects  of  the  new  legislation  upon  the  State 
banks.  At  the  outset  it  should  be  noted  that  some  of  the 
State  banks  will  find  themselves  unable  to  decide  the  case 
on  its  merits  because  of  restrictions  in  their  State  laws.  lu 
many  States  it  is  illegal  for  banks  to  own  stock  in  other 
banking  institutions,  and  there  has  already  developed  a 
considerable  difference  of  opinion  as  to  whether  this  re- 
striction forbids  the  purchase  of  stock  in  the  Federal  re- 
serve banks.  It  is  reported  that  the  Attorney  General  of 
Michigan,  in  response  to  a  request  for  a  ruling  from  the 
State  Banking  Commissioner,  has  rendered  an  opinion  to 
the  effect  that  under  the  Michigan  banking  law  State  banks 
can  not  purchase  the  Federal  reserve  bank  stock.  On  the 
other  hand,  in  Missouri  the  Governor  and  the  Attorney 
General  are  said  to  agree  that  the  Missouri  statute  pro- 
hibiting one  corporation  from  holding  the  stock  of  another 
is  not  applicable  to  corporations  which  acquire  stock  of 
another  concern  engaged  in  something  Avhich  is  incident 
to  the  business  and  welfare  of  the  corporation  acquiring 
such  stock. 

These  difficulties  are  perhaps  only  temporary  and  of 
minor  importance  in  the  long  run,  but  must,  of  course,  be 
removed  before  action  may  be  taken  by  many  State  insti- 
tutions. In  this  connection  it  should  be  noted  thnt  the 
State  banks  are  not  compelled  to  join  the  system  as  are 
the  national  banks.  National  lianks  in  reserve  and  central 
reserve  cities  must  make  apj)lieation  for  membership  prior 
to  February  22,  1914,  or  cease  to  act  as  reserve  agents. 
All  national  l);inks  must  enter  the  system  prior  to  Decem- 
ber 23,  1914,  or  forfeit  their  charters.     State  banks,  how- 


374      OPERATION  OF  THE  NEW  BANK  ACT 

ever,  are  free  to  watch  the  new  system  for  a  time  and  deter- 
mine their  course  of  action  by  its  success  or  failure.  No 
time  limit  is  set  for  their  entrance,  and  there  is  no  reason 
why  they  should  hasten  to  join  in  case  they  feel  disposed 
to  delay. 

Advantages  of  Entering  the  System. — Among  the  ad- 
vantages that  will  accrue  to  all  State  banks  upon  entering 
the  system,  we  may  notice,  first,  that  there  is  offered  a 
probable  six  per  cent  return  on  the  money  paid  in  on  stock 
subscriptions.  This  is,  of  course,  dependent  upon  the  suc- 
cess of  the  reserve  banks.  Another  advantage  is  the  addi- 
tional prestige  and  influence  that  will  come  from  Federal 
supervision  with  the  strict  examinations  that  are  conducted 
by  the  Federal  officials  and  the  rigid  reports  that  must  be 
made  in  response  to  the  calls  of  the  Comptroller.  No 
matter  what  the  disadvantages,  this  advantage  will  doubt- 
less be  of  value  in  attracting  business. 

Rediscounting  and  Securing  Reserve  Notes. — Turning 
from  these  less  certain  and  somewhat  intangible  advan- 
tages to  those  that  are  more  positive,  the  right  that  is  given 
to  all  member  banks  in  the  system  to  rediscount  their  paper 
and  secure  Federal  reserve  notes  is  first  in  order  of  im- 
portance. The  value  of  this  may  be  somewhat  problematical 
until  experience  shows  the  extent  to  which  State  institu- 
tions will  be  willing  to  abandon  their  objections  to  redis- 
counting— a  feeling  which  they  share  with  the  national 
banks.  If  they  can  bring  themselves  to  a  belief  that  such  a 
practice  is  good  banking,  they  will  have  at  their  disposal 
a  means  of  securing  prompt  action  in  time  of  need  and 
through  their  membership  in  the  system  will  have  access 
to  the  concentrated  reserves  of  the  entire  United  States. 
The  reserve  bank  wall  be  able  to  focus  its  power  upon  any 
weak  spot  in  the  entire  district  and  if  necessary  will  be 
able  to  secure,  with  the  approval  of  the  Federal  Reserve 
Board,  the  aid  of  every  other  reserve  bank  in  the  United 
States.  Without  membership  in  the  system  the  State  banks 
may,  of  course,  be  able  to  secure  a  certain  amount  of  assist- 
ance from  their  reserve  agents,  as  in  the  past.    They  may 


STATE  BANKS  AND  THE  NEW  LAW        375 

even  be  able  to  get  help  from  the  reserve  banks  by  securing 
discounts  through  a  member  bank,  if  the  Reserve  Board, 
under  the  power  conferred  in  Section  19,  should  permit  it. 
Such  permission,  if  given  at  all,  will  probably  be  granted 
only  when  the  situation  is  very  serious. 

Along  with  this  advantage,  although  perhaps  of  minor 
importance  to  most  State  institutions,  is  the  right  to  accept 
drafts  or  bills  of  exchange  drawn  upon  them  *  *  growing  out 
of  transactions  involving  the  importation  or  exportation 
of  goods  having  more  than  six  months'  sight  to  run." 
These  acceptances  are  not  to  exceed  in  amount  one-half  of 
the  paid-up  capital  stock  and  surplus  of  the  accepting  in- 
stitution and  may  be  rediscounted  if  desired  with  the 
Federal  reserve  bank.  To  some  institutions  this  privilege 
will  be  of  value. 

The  New  Reserve  Requirements. — The  reserve  re- 
quirements of  the  new  system  may  prove  to  be  an  advantage 
to  some  State  banks  and  a  disadvantage  to  others.  Thus 
in  New  York  City  the  banlcs  in  I\Ianhattan  are  now  re- 
quired to  maintain  reserves  of  twenty-five  per  cent,  fifteen 
per  cent  of  which  must  be  in  cash  in  their  vaults  and  ten 
per  cent  of  which  may  be  on  deposit  with  other  banks  or 
trust  companies  approved  by  the  Superintendent  of  Bank- 
ing. If  in  the  Federal  reserve  system  these  banks  would 
have  to  keep  in  the  reserve  bank  of  this  district  a  sum 
equal  to  seven  per  cent  of  their  demand  deposits.  In 
the  absence  of  any  change  in  the  law  this  would  mean  a 
total  reserve  of  thirty-two  per  cent  for  Manhattan  State 
banks  joining  the  system,  since  the  reserve  bank  to  be  es- 
tablished is  not  among  the  approved  depositaries.  It  may 
be  that  this  difficulty  can  be  obviated  by  the  State  Super- 
intendent <lesignating  the  reserve  bank  of  the  New  York 
district  as  a  depositary  for  State  institutions.  Ina.smuch 
as  the  national  banks  of  New  York  City  will  be  required 
to  keep  only  eighteen  per  cent  resein'c,  of  which  only 
six  per  cent  need  be  in  their  own  vaults,  this  point  is  of 
considerable  significance.  In  some  States,  of  course,  the 
new  law  will  impose  a  higher  requirement  than  that  now 


376       OPERATION  OF  THE  NEW  BANK  ACT 

imposed  by  the  State  statutes,  although  in  a  considerable 
number  of  cases  there  will  be  no  appreciable  difference. 

Before  leaving  the  subject  of  required  reserves,  atten- 
tion should  be  called  to  the  statement  in  Section  ]0  that 
reserves  of  State  institutions  that  may  be  legally  kept  with 
another  State  bank  may  be  counted  as  reserves  within  the 
meaning  of  the  law  during  the  first  three  years  after  the 
establishment  of  the  reserve  bank  within  the  district,  just 
as  though  they  were  deposits  in  a  national  bank  in  a  reserve 
or  central  reserve  city.  Except  as  thus  provided,  however, 
"no  member  bank  shall  keep  on  deposit  with  any  non- 
member  bank  a  sum  in  excess  of  ten  per  centum  of  its  own 
paid-up  capital  and  surplus." 

Checks  Cleared  at  Par. — The  most  important  of  the 
advantages  to  State  institutions  entering  the  system  is 
that  they  will  be  able  to  receive  from  the  reserve  banks 
immediate  credit  at  par  for  all  checks  and  drafts  on  other 
member  banks  within  the  district  and  will  also  be  able, 
through  the  same  provisions  of  the  Act,  to  have  checks  and 
drafts  on  themselves  pass  at  par  within  the  district.  This, 
and  the  possibility  of  having  their  checks  pass  at  par 
throughout  the  entire  United  States,  have  been  fully  dis- 
cussed in  the  chapter  on  "Clearing  Checks  and  Drafts" 
and  need  not  be  repeated  here.  In  this  connection  it  may 
be  noticed  that  under  the  provisions  quoted  at  the  end  of 
the  preceding  paragraph,  many  State  institutions  now  act- 
ing as  depositaries  for  other  banks  will,  unless  they  enter, 
be  compelled  to  surrender  most  of  the  sums  so  held  if  the 
banks  to  which  the  deposits  belong  join  the  system. 

Finally,  attention  should  be  called  to  the  right  of  the 
State  banks  to  continue  all  practices  allowed  by  their  State 
laws  that  are  not  in  conflict  with  the  Act.  Among  these 
are  the  right  to  establish  branches,  which  is  permitted  in 
some  States,  and  the  right  to  lend  on  real  estate  to  a  greater 
extent  than  may  the  national  banks. 

Disadvantages  of  Entrance. — The  disadvantages  of 
entrance  are  by  no  means  to  be  ignored.  To  some  institu- 
tions the  requirement  that  the  capital  of  the  State  bankf? 


STATE  BANKS  AND  THE  NEW  LAW         377 

that  enter  must  be  equal  to  that  required  for  national  banks 
in  localities  of  the  same  population  will  be  a  distinct  hard- 
ship. Some  of  the  States  allow  banks  to  be  capitalized  for 
as  small  an  amount  as  $10,000.  This  fact  alone  will  doubt- 
less keep  many  out.  In  some  instances  the  reserve  require- 
ments may  have  the  same  effect,  although  this  difficulty  is 
lessened  by  the  fact  that  a  large  amount  of  the  deposits 
of  State  banks  in  some  parts  of  the  country  are  time  de- 
posits and  the  new  law  requires  only  a  five  per  cent  reserve 
against  them. 

A  third  disadvantage  to  some  banks  will  be  found  in 
the  strict  Federal  examinations  and  reports,  which  will 
be  viewed  as  burdensome  by  those  which  desire  to  conduct 
their  business  along  lines  which  perhaps  yield  large  profits 
but  involve  great  risks.  Still  another  limitation  that  will 
be  imposed  is  that  no  member  bank  will  be  allowed  to  lend 
to  any  one  individual  an  amount  in  excess  of  ten  per  cent 
of  its  capital,  whereas  the  State  banks  in  some  cases  allow 
twenty,  thirty  or  even  fifty  per  cent  to  be  so  loaned  if 
properly  secured.  Finally,  many  of  the  State  banks  will 
have  but  little  paper  of  the  sort  that  will  be  acceptable  for 
rediscount  at  the  reserve  banks. 

Importance  of  the  State  Banks. — The  importance  of 
State  institutions  in  detormining  the  measure  of  success 
of  the  system  may  be  emphasized  by  calling  attention  to  the 
fact  that  in  some  States  they  outnumber  the  national  banks. 
Thus,  in  Missouri,  there  are  1,231  Stato  banks  with  a  capi- 
tal of  $58,000,000  and  deposits  of  $298,000,000,  as  com- 
pared with  133  national  banks  with  a  capital  of  $36,000,000 
and  deposits  of  $152,000,000.  Tn  Kan.sas  there  are  004 
State  banks  with  a  capital  of  $19,000,000  and  depo.sits  of 
$99,000,000,  while  the  national  banks  number  206  with  a 
capital  of  $11,367,500  and  deposits  of  $61,000,000.  Tn 
Minnesota  thero  are  759  State  banks  with  n  capital  of 
$17,400,000  and  deposits  of  $218,000,000.  whiln  the  national 
banks  number  272,  with  a  capital  of  $22,700,000  and  de- 
posits of  $105,000,000. 

Conclusions, — Tt  is  hard  to  draw  general  conclusions 


378       OPERATION  OF  THE  NEW  BANK  ACT 

because  of  the  varying  conditions  prevailing  in  different 
States.  Banks  in  some  States  will  find  that  the  laws  under 
which  they  now  operate  differ  so  little  from  the  require- 
ments for  national  banks  that  there  will  be  very  litth?  fric- 
tion involved  in  entering.  Others  will  find  such  wide 
differences  that  accommodation  to  the  new  requirements  will 
be  difficult.  It  may  be  in  point  again  to  observe  that  the 
State  institutions  are  not  required  to  enter  and  may  very 
properly  wait  until  they  have  had  time  for  observation. 
Most  of  the  rights  which  they  now  hold  as  State  banks  can 
be  retained.  Whatever  pressure  there  is  upon  them  to 
enter  the  system  will  arise  out  of  the  fact  that  membership 
will  confer  new  advantages  upon  those  that  join  and  will 
consequently  place  at  a  disadvantage  those  that  do  not. 
The  national  banks,  to  a  limited  extent,  may  hereafter  com- 
pete with  the  State  banks  for  farm  loans.  They  may,  by 
securing  special  permission  from  the  Federal  Reserve  Board, 
act  as  trustee,  executor,  administrator  and  registrar  of 
stocks  and  bonds.  This  competition  by  the  national  banks 
may  in  itself  be  sufficient  to  compel  some  State  banks  to 
join. 

Probably  the  most  important  factor  influencing  the  ac- 
tion of  the  State  banks  will  center  about  the  possibility  of 
collecting  checks  and  drafts  at  par.  This  may  be  a  distinct 
advantage  to  some  banks  and  may  be  the  force  which  will 
compel  many  to  enter.  How  this  will  operate  will  be  deter- 
mined largely  by  the  rulings  of  the  Reserve  Board.  If  the 
board  promptly  requires  each  reserve  bank  to  act  as  a 
clearing  house  for  member  banks  within  its  own  district, 
the  cheeks  and  drafts  upon  these  institutions  will,  doubt- 
less, pass  at  par.  Any  bank  whose  checks  and  drafts  do  not 
pass  will  be  placed  at  a  distinct  disadvantage  and  will 
doubtless  lose  a  large  amount  of  business. 


FEDERAL  RESERVE  ACT 

[Public — No.  43 — 63d  Congress] 
(H.  R.  7837] 

An  Act  To  provide  for  the  establishment  of  Federal  reserve  banks,  to  furnish 
an  elastic  currency,  to  afford  means  of  rediscounting  commercial  paper,  to  establish 
a  more  effective  supervision  of  banking  in  the  United  States,  and  for  other  purposes. 

Be  it  enacted  by  the  Senate  and  House  of  Representatives  of 
the  United  States  of  America  in  Congress  assembled,  That  the  short 
title  of  tliis  Act  sliall  be  the  "  Federal  Reserve  Act." 

Wherever  the  word  *'  bank  "  is  used  in  this  Act,  the  word  shall 
be  held  to  include  State  bank,  banking  association,  and  trust  com- 
pany, except  where  national  banks  or  Federal  reserve  banks  are 
specifically  referred  to. 

The  terms  "  national  bank  "  and  "  national  banking  association  " 
used  in  this  Act  sliall  be  held  to  be  synonymous  and  interchange- 
able. The  term  "  member  bank "  shall  be  held  to  mean  any 
national  bank,  State  bank,  or  bank  or  trust  company  which  has  be- 
come a  member  of  one  of  the  reserve  banks  created  by  this  Act. 
Tiie  term  "  board  "  sliall  be  held  to  mean  Federal  Reserve  Board ; 
the  term  "district"  shall  be  held  to  mean  Federal  reserve  district; 
tlie  term  "  reserve  bank  "  shall  be  held  to  mean  Federal  reserve  bank. 

Federal  Reserve  Districts 

Sec.  2.  As  soon  as  practicable,  the  Secretary  of  the  Treasury, 
the  Secretary  of  Agriculture  and  the  Comptroller  of  the  Currency, 
acting  as  "  The  Reserve  Bank  Organization  Committee,"  sliall  desig- 
nate not  less  than  eight  nor  more  than  twelve  cities  to  be  known  as 
Federal  reserve  cities,  and  shall  divide  the  continental  United 
States,  excluding  Alaska,  into  districts,  each  district  to  contain  only 
one  of  sucli  Federal  reserve  cities.  The  determination  of  said 
organization  committee  shall  not  be  subject  to  review  except  by  the 
Federal  Reserve  Board  when  organized:  Prodded,  Tliat  the  dis- 
tricts shall  be  apportioned  with  due  regard  to  the  convenience  and 
customary  course  of  business  and  shall  not  necessarily  be  cotermi- 
nous with  any  State  or  States.  The  districts  thus  created  may  be 
readjusted  and  new  districts  may  from  time  to  time  l)e  created  by 
the  Federal  Reserve  Board,  not  to  exceed  twelve  in  all.  Such  dis- 
tricts shall  be  known  as  Federal  reserve  districts  and  may  be 
designated  by  nunil>er.  A  majority  of  the  organization  committee 
shall  constitute  a  quorum  witli  autiiority  to  act. 

Said  organization  committee  shall  be  authorized  to  employ 
counsel  and  expert  aid,  to  take  testimony,  to  send  for  persons  and 
papers,  to  administer  oaths,  and  to  make  such  investigation  as  may 
be  deemed  necessary  i)y  the  said  committee  in  determining  the  re- 
serve districts  and  in  designating  the  cities  within  sucli  districts 
where  such  Federal  reserve  banks  shall  be  severally  located.     The 

379 


380      OPERATION  OF  THE  NEW  BANK  ACT 

said  committee  shall  supervise  the  organization  in  each  of  the 
cities  designated  of  a  Federal  reserve  bank,  which  shall  include  in  its 
title  the  name  of  the  city  in  which  it  is  situated,  as  "  Federal  Re- 
serve Bank  of  Cliicago." 

Under  regulations  to  be  prescribed  by  the  organization  com- 
mittee, every  national  banking  association  in  the  United  States  is 
hereby  required,  and  every  eligible  bank  in  the  United  States  and 
every  trust  company  within  the  District  of  Columbia  is  liereby 
autliorized,  to  signify  in  writing,  within  sixty  days  after  the  passage 
of  this  Act,  its  acceptance  of  the  terms  and  provisions  hereof. 
When  the  organization  committee  shall  have  designated  tlie  cities 
in  which  Federal  reserve  banks  are  to  be  organized,  and  fixed  the 
geographical  limits  of  the  Federal  reserve  districts,  every  national 
banking  association  within  that  district  shall  be  required  within 
thirty  days  after  notice  from  the  organization  committee,  to  sub- 
scribe to  the  capital  stock  of  such  Federal  reserve  bank  in  a  sum 
equal  to  six  per  centum  of  the  paid-up  capital  stock  and  surplus  of 
such  bank,  one-sixth  of  the  subscription  to  be  payable  on  call  of  the 
organization  committee  or  of  the  Federal  Reserve  Board,  one-sixth 
within  three  months  and  one-sixth  within  six  months  thereafter, 
and  the  remainder  of  the  subscription,  or  anj'  part  thereof,  shall  be 
subject  to  call  when  deemed  necessary  by  the  Federal  Reserve 
Board,  said  payments  to  be  in  gold  or  gold  certificates. 

The  shareholders  of  every  Federal  reserve  bank  sliall  be  held 
individually  responsible,  equally  and  ratably,  and  not  one  for 
another,  for  all  contracts,  debts,  and  engagements  of  such  bank  to 
the  extent  of  the  amount  of  their  subscriptions  to  such  stock  at  the 
par  value  thereof  in  addition  to  the  amount  subscribed,  whether 
such  subscriptions  have  been  paid  up  in  whole  or  in  part,  under 
the  provisions  of  this  Act. 

Any  national  bank  failing  to  signify  its  acceptance  of  tiie 
terms  of  this  Act  within  the  sixty  days  aforesaid,  shall  cease  to 
act  as  a  reserve  agent,  upon  thirty  days'  notice,  to  be  given  within 
the  discretion  of  the  said  organization  committee  or  of  the  Federal 
Reserve  Board. 

Should  any  national  banking  association  in  the  United  States 
now  organized  fail  within  one  year  after  the  passage  of  this  Act 
to  become  a  member  bank  or  fail  to  comply  wnth  any  of  the  pro- 
visions of  this  Act  applicable  thereto,  all  of  the  rights,  privileges,  and 
franchises  of  such  association  granted  to  it  under  the  national-bank 
Act,  or  under  the  provisions  of  this  Act,  shall  be  thereby  forfeited. 
Any  noncompliance  with  or  violation  of  this  Act  shall,  however,  be 
determined  and  adjudged  by  any  court  of  the  United  States  of 
competent  jurisdiction  in  a  suit  brought  for  that  purpose  in  the 
district  or  territory  in  which  such  bank  is  located,  under  direction 
of  the  Federal  Reserve  Board,  by  the  Comptroller  of  the  Currency 
in  his  own  name  before  tlie  association  shall  be  declared  dissolved. 
In  cases  of  such  noncompliance  or  violation,  other  than  the  failure 
to  become  a  member  bank  under  the  provisions  of  this  Act,  every 
director  who  participated  in  or  assented  to  the  same  shall  be  held 
liable  in  his  personal  or  individual  capacity  for  all  damages  which 


FEDERAL  RESERVE  ACT  381 

said  bank,  its  shareholders,  or  any  other  person  shall  have  sus- 
tained in  consequence  of  such  viohition. 

Such  dissolution  shall  not  take  away  or  impair  any  remedy 
against  such  corporation,  its  stockliolders  or  officers,  for  any  liability 
or  penalty  which  sliall  have  been  previously  incurred. 

Sliould  the  subscriptions  by  banks  to  the  stock  of  said  Federal 
reserve  banks  or  any  one  or  more  of  them  be,  in  tlie  judgment  of  the 
organization  committee,  insufficient  to  provide  the  amount  of 
capital  required  therefor,  then  and  in  that  event  the  said  organiza- 
tion committee  may,  under  conditions  and  regulations  to  be  pre- 
scribed by  it,  offer  to  public  subscription  at  par  sucli  an  amount  of 
stock  in  said  Federal  reserve  banks,  or  any  one  or  more  of  them,  as 
said  committee  shall  determine,  subject  to  the  same  conditions  as  to 
pay7nent  and  stock  li.abilitj'  as  provided  for  member  banks. 

No  individual,  copartnership,  or  corporation  other  than  a 
member  bank  of  its  district  shall  be  permitted  to  subscribe  for  or 
to  hold  at  any  time  more  than  $2.5,000  par  value  of  stock  in  any 
Federal  reserve  bank.  Such  stock  shall  be  known  as  public  stock 
and  may  be  transferred  on  tlie  books  of  the  Federal  reserve  bank  by 
the  chairman  of  the  board  of  directors  of  such  bank. 

Should  the  total  subscriptions  by  banks  and  the  public  to  the 
stock  of  said  Federal  reserve  banks,  or  any  one  or  more  of  tliem,  be, 
in  the  judgment  of  the  organization  committee,  insufficient  to  pro- 
vide the  amount  of  capital  required  therefor,  then  and  in  that 
event  the  said  organization  committee  shall  allot  to  the  United 
States  sucli  an  amount  of  said  stock  as  said  committee  sliall  deter- 
mine. Said  United  States  stock  shall  be  paid  for  at  par  out  of  any 
money  in  the  Treasury  not  otherwise  appropriated,  and  shall  be 
held  by  the  Secretary  of  the  Treasury  and  disposed  of  for  the 
benefit  of  the  United  States  in  such  manner,  at  such  times,  and  at 
such  price,  not  less  than  par,  as  the  Secretary  of  the  Treasury  shall 
determine. 

Stock  not  held  by  member  banks  shall  not  be  entitled  to  voting 
power. 

The  Federal  Reserve  Board  is  hereby  empowered  to  adopt  and 
promulgate  rules  and  regulations  governing  the  transfers  of  said 
stock. 

No  Federal  reserve  bank  shall  commence  business  with  a  sub- 
scribed capital  less  than  .$4,000,000.  The  organization  of  reserve 
districts  and  Federal  reserve  cities  shall  not  be  construed  as 
changing  the  present  status  of  reserve  cities  and  central  reserve 
cities,  except  in  so  far  as  this  Act  changes  the  amount  of  reserves 
that  may  be  carried  witli  approved  reserve  agents  located  therein. 
The  organization  committee  shall  have  power  to  appoint  such 
assistants  and  incur  such  expenses  in  carrying  out  the  provisions 
of  this  Act  as  it  shall  deem  necessary,  and  such  expenses  shall  l»e 
payable  by  the  Treasurer  of  the  United  States  upon  voucher  ap- 
proved by  the  Secretary  of  the  Treasury,  and  the  sum  of  $100,000. 
or  so  much  thereof  as  may  be  necessary,  is  hereby  appropriated,  out 
of  any  moneys  in  the  Treasury  not  otherwise  appropriated,  for  the 
payment  of  such  expenses. 


382       OPERATION  OF  THE  NEW  BANK  ACT 

Branch  Offices 

Sec.  3,  Each  Federal  reserve  bank  shall  establish  branch  banks 
witliin  the  Federal  reserve  district  in  which  it  is  located  and  may  do 
so  in  the  district  of  any  Federal  reserve  bank  which  may  have  been 
suspended.  Such  branches  shall  be  operated  by  a  board  of  directors 
under  rules  and  regulations  approved  by  the  Federal  Reserve  Board. 
Directors  of  branch  banks  shall  possess  the  same  qualifications  as 
directors  of  the  Federal  reserve  banks.  Four  of  said  directors  shall 
be  selected  by  the  reserve  bank  and  three  by  the  Federal  Reserve 
Board,  and  they  shall  hold  office  during  the  pleasure,  respectively, 
of  the  parent  bank  and  the  Federal  Reserve  Board.  The  reserve 
bank  shall  designate  one  of  the  directors  as  manager. 

Federal  Reserve  Banks 

Sec.  4.  When  the  organization  committee  shall  have  established 
Federal  reserve  districts  as  provided  in  section  two  of  this  Act,  a 
certificate  shall  be  filed  with  the  Comptroller  of  tlie  Currency  show- 
ing the  geographical  limits  of  such  districts  and  the  Federal  reserve 
city  designated  in  each  of  such  districts.  The  Comptroller  of  the 
Currency  shall  thereupon  cause  to  be  forwarded  to  each  national 
bank  located  in  each  district,  and  to  such  other  banks  declared  to  be 
eligible  by  the  organization  committee  which  may  apply  therefor,  an 
application  blank  in  form  to  be  approved  by  the  organization  com- 
mittee, which  blank  shall  contain  a  resolution  to  be  adopted  by  the 
board  of  directors  of  each  bank  executing  such  application,  author- 
izing a  subscription  to  the  capital  stock  of  the  Federal  reserve  bank 
organizing  in  that  district  in  accordance  with  the  provisions  of  this 
Act. 

When  the  minimum  amount  of  capital  stock  prescribed  by  this 
Act  for  the  organization  of  any  Federal  resene  bank  sliall  have  been 
subscribed  and  allotted,  the  organization  committee  shall  designate 
any  five  banks  of  those  whose  applications  have  been  received,  to 
execute  a  certificate  of  organization,  and  thereupon  the  banks  so 
designated  shall,  under  their  seals,  make  an  organization  certificate 
which  shall  specifically  state  the  name  of  such  Federal  reserve  bank, 
the  territorial  extent  of  the  district  over  which  the  operations  of  such 
Federal  reserve  bank  are  to  be  carried  on.  the  city  and  State  in  which 
said  bank  is  to  be  located,  the  amount  of  capital  stock  and  the  num- 
ber of  shares  into  which  the  same  is  divided,  the  name  and  place  of 
doing  business  of  each  bank  executing  such  certificate,  and  of  all 
banks  which  have  subscribed  to  the  capital  stock  of  such  Federal 
reserve  bank  and  the  nimiber  of  shares  subscribed  by  each,  and  the 
fact  that  the  certificate  is  made  to  enable  those  banks  executing 
same,  and  all  banks  which  have  subscribed  or  may  thereafter  sub- 
scribe to  the  capital  stock  of  such  Federal  reserve  bank,  to  avail 
themselves  of  the  advantages  of  this  Act. 

The  said  organization  certificate  shall  be  acknowledged  before  a 
judge  of  some  court  of  record  or  notary  public;  and  shall  be.  to- 
gether with  the  acknowledgment  thereof,  authenticated  by  the  seal 
of  such  court,  or  notary,  transmitted  to  the  Comptroller  of  the 
Currency,  who  shall  file,  record  and  carefully  preserve  the  same  in 
his  oflBce. 


FEDERAL  RESERVE  ACT  383 

upon  the  liliiig  of  sucli  certificate  witli  tlie  Coiuptrolier  of  tlie 
Currency  as  aforesaid,  the  said  Federal  reserve  bank  sliall  become  a 
body  corporate  and  as  such,  and  in  the  name  designated  in  such 
organization    certificate,    sliall    have    power — 

First.     To  adopt  and  use  a  corporate  seal. 

Second.  To  have  succession  for  a  period  of  twenty  years  from 
its  organization  unless  it  is  sooner  dissolved  by  an  Act  of  Congress, 
or  unless  its  franchise  becomes  forfeited  by  some  violation  of  law. 

Third.     To  make  contracts. 

Fourth.  To  sue  and  be  sued,  complain  and  defend,  in  any 
court  of  law  or  equity. 

Fifth.  To  appoint  by  its  board  of  directors,  such  otiicers  and 
employees  as  are  not  otherwise  provided  for  in  this  Act,  to  deline 
their  duties,  require  bonds  of  them  and  fix  the  penalty  thereof,  and 
to  dismiss   at  pleasure   such  officers  or  employees. 

Sixth.  To  prescribe  by  its  board  of  directors,  by-laws  not  in- 
consistent with  law,  regulating  the  manner  in  which  its  general 
business  may  be  conducted,  and  the  privileges  granted  to  it  by  law 
may  be  exercised  and  enjoyed. 

Seventh.  To  exercise  by  its  board  of  directors,  or  duly  author- 
ized officers  or  agents,  all  powers  specifically  granted  by  the  pro- 
visions of  this  Act  and  such  incidental  powers  as  shall  be  necessary 
to  carry  on  the  business  of  banking  within  the  limitations  pre- 
scribed by  this  Act. 

Eighth.  Upon  deposit  with  the  Treasurer  of  the  United  States 
of  any  bonds  of  the  United  States  in  the  manner  provided  by 
existing  law  relating  to  national  banks,  to  receive  from  the  Comp- 
troller of  the  Currency  circulating  notes  in  blank,  registered  and 
countersigned  as  provided  by  law,  equal  in  amount  to  the  par  value 
of  the  bonds  so  deposited,  such  notes  to  be  issued  under  the  same 
conditions  and  provisions  of  law  as  relate  to  the  issue  of  circulat- 
ing notes  of  national  banks  secured  by  bonds  of  the  United  Stales 
bearing  tiie  circulating  privilege,  except  that  the  issue  of  such 
notes  shall  not  be  limited  to  the  capital  stock  of  sucli  Federal 
reserve  bank. 

But  no  Federal  reserve  bank  shall  transact  any  business  except 
such  as  is  incidental  and  necessarily  preliminary  to  its  organiza- 
tion until  it  has  been  autiiorized  by  the  Comptroller  of  the  Currency 
to  commence  business  under  the  provisions  of  this  Act. 

Every  Federal  reserve  bank  shall  be  conducted  under  the  super- 
vision and  control  of  a  board  of  directors.    ' 

The  board  of  directors  sliall  perform  the  duties  usually  apper- 
taining to  the  office  of  directors  of  banking  at^sociations  and  all  such 
duties  as  are  prescribed  by  law. 

Said  board  shall  administer  the  afTairs  of  said  bank  fairly  and 
impartially  and  witliout  discrimination  in  favor  of  or  against  any 
member  bunk  or  banks  and  shall,  subject  to  the  provisions  of  law 
and  the  orders  of  the  Federal  Reserve  Board,  extend  to  each  member 
bank  such  discounts,  advancements  and  accommodations  as  may  be 
safely  and  reasonably  made  with  due  regard  for  the  claims  and  de- 
mands of  other  member  banks. 

Such  board  of  directors  shall  be  selected  as  hereinafter  specified 


384       OrERATION  OF  THE  NEW  BANK  ACT 

and  shall  consist  of  nine  meiubers,  holding  otlice  for  three  yeard,  and 
divided  into  three  classes,  designated  as  classes  A,  B,  and  C. 

Class  A  shall  consist  of  three  members,  who  shall  be  chosen  by 
and  be  representative  of  the  stock-holding  banks. 

Class  B  shall  consist  of  three  members,  who  at  the  time  of  their 
election  shall  be  actively  engaged  in  their  district  in  commerce, 
agriculture  or  some  other  industrial  pursuit. 

Class  C  shall  consist  of  three  members  who  shall  be  designated 
by  the  Federal  Reserve  Board.  When  the  necessary  subscriptions 
to  the  capital  stock  have  been  obtained  for  the  organization  of  any 
Federal  reserve  bank,  the  Federal  Reserve  Board  shall  appoint  the 
class  C  directors  and  shall  designate  one  of  such  directors  as  chair- 
man of  the  board  to  be  selected.  Pending  the  designation  of  such 
chairman,  the  organization  committee  shall  exercise  the  powers  and 
duties  appertaining  to  the  office  of  chairman  in  the  organization  of 
such  Federal  reserve  bank. 

No  Senator  or  Representative  in  Congress  shall  be  a  member  of 
the  Federal  Reserve  Board  or  an  officer  or  a  director  of  a  Federal 
reserve  bank. 

No  director  of  class  B  shall  be  an  officer,  director,  or  employee 
of  any  bank. 

No  director  of  class  C  shall  be  an  officer,  director,  employee,  or 
stockholder  of  any  bank. 

Directors  of  class  A  and  class  B  shall  be  chosen  in  the  following 
manner : 

The  chairman  of  the  board  of  directors  of  the  Federal  reserve 
bank  of  the  district  in  which  the  bank  is  situated  or,  pending  the 
appointment  of  such  chairman,  the  organization  committee  shall 
classify  the  member  banks  of  the  district  into  three  general  groups 
or  divisions.  Each  group  shall  contain  as  nearly  as  may  be  one- 
third  of  the  aggregate  number  of  the  member  banks  of  the  district 
and  shall  consist,  as  nearly  as  may  be,  of  banks  of  similar  capitaliza- 
tion.    The  groups  shall  be  designated  by  number  by  the  chairman. 

At  a  regularly  called  meeting  of  the  board  of  directors  of  each 
member  bank  in  the  district  it  shall  elect  by  ballot  a  district 
reserve  elector  and  shall  certify  his  name  to  the  chairman  of  the 
board  of  directors  of  the  Federal  reserve  bank  of  the  district.  The 
chairman  shall  make  lists  of  the  district  reserve  electors  thus 
named  by  banks  in  each  of  the  aforesaid  three  groups  and  shall 
transmit  one  list  to  each  elector  in  each  group. 

Each  member  bank  shall  be  permitted  to  nominate  to  the  chair- 
man one  candidate  for  director  of  class  A  and  one  candidate  for 
director  of  class  B.  The  candidates  so  nominated  shall  be  listed  by 
the  chairman,  indicating  by  whom  nominated,  and  a  copy  of  said  list 
shall,  within  fifteen  days  after  its  completion,  be  furnislied  by  the 
chairman  to  each  elector. 

Every  elector  shall,  within  fifteen  days  after  the  receipt  of  the 
said  list,  certify  to  the  chairman  his  first,  second,  and  other  choices 
of  a  director  of  class  A  and  class  B,  respeetiA-ely.  upon  a  preferential 
ballot,  on  a  form  furnished  by  the  chairman  of  the  board  of 
directors  of  the  Federal  reserve  bank  of  the  district.  Each  elector 
shall  make  a  cross  opposite  the  name  of  the  first,  second,  and  other 


FEDERAL  RESERVE  ACT  385 

choices  for  a  director  of  class  A  and  for  a  director  of  class  B,  but 
shall  not  vote  more  than  one  choice  for  any  one  candidate. 

Any  candidate  iiaving  a  majority  of  all  votes  cast  in  the 
column  of  first  choice  shall  be  declared  elected.  If  no  candidate 
have  a  majority  of  all  the  votes  in  the  first  column,  then  there  shall 
l)e  added  together  the  votes  cast  by  the  electors  for  sucli  candidates 
in  the  second  column  and  the  votes  cast  for  the  several  candidates 
in  the  first  column.  If  any  candidate  then  have  a  majority  of  tlie 
electors  voting,  by  adding  together  the  first  and  second  choices,  he 
shall  be  declared  elected.  If  no  candidate  have  a  majority  of 
electors  voting  when  the  first  and  second  choices  shall  have  been 
added,  then  the  votes  cast  in  the  third  column  for  other  choices 
shall  be  added  together  in  like  manner,  and  the  candidate  then 
having  4he  highest  number  of  votes  shall  be  declared  elected.  An 
immediate   report  of   election   shall   be   declared. 

Class  C  directors  shall  bo  appointed  by  the  Federal  Reserve 
Board.  They  shall  have  been  for  at  least  two  years  residents  of  the 
district  for  which  they  are  appointed,  one  of  whom  shall  be  desig- 
nated by  said  board  as  chairman  of  the  board  of  directors  of  the 
Federal  reserve  bank  and  as  "  Federal  reserve  agent."  He  shall  be 
a  person  of  tested  banking  experience;  and  in  addition  to  his  duties 
as  chairman  of  the  board  of  directors  of  the  Federal  reserve  bank 
he  shall  be  required  to  maintain  under  regulations  to  be  established 
by  the  Federal  Reserve  Board  a  local  oflfice  of  said  board  on  the 
premises  of  the  Federal  reserve  bank.  He  shall  make  regular 
reports  to  the  Federal  Reserve  Board,  and  shall  act  as  its  official 
representative  for  the  performance  of  the  functions  conferred  upon 
it  by  this  Act.  He  shall  receive  an  annual  compensation  to  be  fixed 
by  the  Federal  Reserve  Board  and  paid  monthly  by  the  Federal 
reserve  bank  to  which  he  is  designated.  One  of  the  directors  of 
class  C.  who  shall  be  a  person  of  tested  banking  experience,  shall  be 
appointed  by  the  Federal  Reserve  Board  as  deputy  chairman  and 
deputy  Federal  reserve  agent  to  exercise  the  powers  of  the  chairman 
of  the  board  and  Federal  reserve  agent  in  case  of  absence  or  disability 
of  his  principal. 

Directors  of  Federal  reserve  banks  shall  receive,  in  addition  to 
any  compensation  otherwise  provided,  a  reasonable  allowance  for 
necessary  expenses  in  attending  meetings  of  their  respective  boards, 
which  amount  shall  be  paid  by  the  respective  Federal  reserve  banks. 
.Any  compensation  that  may  be  jirovicled  by  boards  of  directors  of 
Federal  reserve  banks  for  directors,  oflicers  or  employees  shall  be 
subject  to  the  approval   of  the  Federal   Reserve  Board. 

The  Reserve  Bank  Organization  Committee  may,  in  organizing 
Federal  reser\'e  banks,  call  such  meetings  of  bank  directors  in  the 
several  districts  as  may  be  necessary  to  carry  ovit  the  purposes  of 
this  Act.  and  may  exercise  the  functions  herein  conferred  upon  the 
chairman  of  the  board  of  directors  of  each  Federal  reserve  bank 
pending  the  complete  organization  of  such   bank. 

At    the    first    meeting   of    the    full    board    of   directors    of   each 

Federal  reserve  bank,  it  shall  be  the  duty  of  the  directors  of  classes 

A,  B  and  C,  respectively,  to  designate  one  of  the  members  of  each 

class  whose   term   of  ofTice   shall   expire   in   one  year   from   the   first 

25 


386       OPERATION  OF  THE  NEW  BANK  ACT 

of  January  nearest  to  date  of  such  meeting,  one  whose  term  of  office 
shall  expire  at  the  end  of  two  years  from  said  date,  and  one  whose 
term  of  oliice  shall  expire  at  tiie  end  of  three  years  from  said  date. 
Thereafter  every  director  of  a  Federal  reserve  bank  chosen  as 
hereinbefore  provided  shall  hold  office  for  a  term  of  tliree  years. 
Vacancies  that  may  occur  in  the  several  classes  of  directors  of 
Federal  reserve  banks  may  be  filled  in  the  manner  provided  for  tiie 
original  selection  of  such  directors,  such  appointees  to  hold  office  for 
the  unexpired  terms  of  their  predecessors. 

Stock  Issues;  Inckease  and  Decrease  of  Capital 

Sec.  5.  The  capital  stock  of  each  Federal  reserve  bank  shall  be 
divided  into  shares  of  $100  each.  The  outstanding  capital  stock 
shall  be  increased  from  time  to  time  as  member  banks  increase 
their  capital  stock  and  surplus  or  as  additional  banks  become 
members,  and  may  be  decreased  as  member  banks  reduce  their 
capital  stock  or  surplus  or  cease  to  be  members.  Shares  of  the 
capital  stock  of  Federal  reserve  banks  owned  by  member  banks  shall 
not  be  transferred  or  hypothecated.  When  a  member  bank  increases 
its  capital  stock  or  surplus,  it  shall  thereupon  subscribe  for  an 
additional  amount  of  capital  stock  of  the  Federal  reserve  bank  of  its 
district  equal  to  six  per  centum  of  the  said  increase,  one-half  of  said 
subscription  to  be  paid  in  the  manner  hereinbefore  provided  for 
original  subscription,  and  one-half  subject  to  call  of  the  Federal 
Reserve  Board.  A  bank  applying  for  stock  in  a  Federal  reserve 
bank  at  any  time  after  the  organization  thereof  must  subscribe 
for  an  amount  of  the  capital  stock  of  the  Federal  reserve  bank  equal 
to  six  per  centum  of  the  paid-up  capital  stock  and  surplus  of  said 
applicant  bank,  paying  therefor  its  par  value  plus  one-half  of  one 
per  centum  a  month  from  the  period  of  the  last  dividend.  When  the 
capital  stock  of  any  Federal  reserve  bank  shall  have  been  increased 
either  on  account  of  the  increase  of  capital  stock  of  member  banks 
or  on  account  of  the  increase  in  the  number  of  member  banks,  the 
board  of  directors  shall  cause  to  be  executed  a  certificate  to  the 
Comptroller  of  the  Currency  showing  the  increase  in  capital  stock, 
the  amount  paid  in,  and  by  whom  paid.  When  a  member  bank 
reduces  its  capital  stock  it  shall  surrender  a  proportionate  amount 
of  its  holdings  in  the  capital  of  said  Federal  reserve  bank,  and 
when  a  member  bank  voluntarily  liquidates  it  sliall  surrender  all 
of  its  holdings  of  the  capital  stock  of  said  Federal  reserve  bank  and 
be  released  from  its  stock  subscription  not  previously  called.  In 
either  case  the  shares  surrendered  shall  be  cancelled  and  the  member 
bank  shall  receive  in  payriient  therefor,  under  regulations  to  be  pre- 
scribed by  the  Federal  Reserve  Board,  a  sum  equal  to  its  cash-paid 
subscriptions  on  the  shares  surrendered  and  one-half  of  one  per 
centum  a  month  from  the  period  of  the  last  dividend,  not  to  exceed 
the  book  value  thereof,  less  any  liability  of  such  member  bank  to 
the  Federal  reserve  bank. 

Sec.  6.  If  any  member  bank  shall  be  declared  insolvent  and  a 
receiver  appointed  therefor,  the  stock  held  by  it  in  said  Federal 
reserve  bank  shall  be  cancelled,  without  impairment  of  its  liability. 


FEDERAL  RESERVE  ACT  387 

and  all  cash-paid  subscriptions  on  said  stock,  with  one-half  of  one 
per  centum  per  month  from  the  period  of  last  dividend,  not  to 
exceed  the  book  value  thereof,  shall  be  first  applied  to  all  debts  of 
the  insolvent  member  bank  to  tlie  Federal  reserve  bank,  and  the 
balance,  if  any,  sliall  be  paid  to  Ibe  receiver  of  tlie  involvent  l)ank. 
Whenever  the  capital  stock  of  a  Federal  reserve  bank  is  reduced, 
either  on  account  of  a  reduction  in  capital  stock  of  any  member 
l)ank  or  of  the  liquidation  or  insolvency  of  such  bank,  tiie  board  of 
directors  shall  cause  to  be  executed  a  certificate  to  the  Comptroller 
of  the  Currency  showing  such  reduction  of  capital  stock  and  the 
amount  repaid  to  such  bank. 

Division  of  Earnings 

Sec.  7.  After  all  necessary  expenses  of  a  Federal  reserve  bank 
have  been  paid  or  provided  for,  the  stockholders  shall  be  entitled  to 
receive  an  annual  dividend  of  six  per  centum  on  tiie  paid-in  capital 
stock,  which  dividend  shall  be  cumulative.  After  the  aforesaid 
dividend  claims  have  been  fully  met,  all  the  net  earnings  shall  be 
paid  to  the  United  States  as  a  franchise  tax,  except  that  one-half 
of  such  net  earnings  shall  be  paid  into  a  surplus  fund  until  it  shall 
amount  to  forty  per  centum  of  the  paid-in  capital  stock  of  such 
bank. 

The  net  earnings  derived  by  the  United  States  from  Federal 
reser^'e  banks  shall,  in  the  discretion  of  the  Secretary,  be  used  to 
supplement  the  gold  reserve  held  against  outstanding  United  States 
notes,  or  shall  be  applied  to  the  reduction  of  the  outstanding  bonded 
indebtedness  of  the  United  States  under  regulations  to  be  prescribed 
by  the  Secretary  of  the  Treasury.  Should  a  Federal  reserve  bank 
be  dissolved  or  go  into  liquidation,  any  surplus  remaining,  after 
the  payment  of  all  debts,  dividend  requirements  as  hereinbefore 
provided,  and  the  par  value  of  the  stock,  shall  be  paid  to  and  be- 
come the  property  of  the  United  States  and  shall  be  similarly 
applied. 

Federal  reserve  banks,  including  the  capital  stock  and  surplus 
therein,  and  the  income  derived  therefrom  shall  be  exempt  from 
Federal,  State,  and  local  taxation,  except  taxes  upon  real  estate. 

Sec.  8.  Section  fifty-one  hundred  and  fifty-four.  United  States 
Revised  Statutes,   is  hereby  amended  to  read  as  follows: 

Any  bank  incorporated  by  special  law  of  any  State  or  of  the 
United  States  or  organized  under  the  general  laws  of  any  State  or  of 
the  ITnited  States  and  having  an  imimpaired  capital  sufficient  to 
entitle  it  to  become  a  national  banking  association  imder  the  pro- 
visions of  the  existing  laws  may.  by  the  vote  of  the  sliareholders 
owning  not  less  than  fifty-one  per  centum  of  the  capital  stock  of 
sncli  bank  or  banking  association,  with  the  approval  of  the  Comp- 
troller of  the  Currency  be  converted  into  a  national  banking  asso- 
ciation, with  any  name  approved  by  the  Comptroller  of  the 
Currency: 

Prnridrd.  hmrrrrr.  That  said  conversion  shall  not  be  in  contra- 
vention of  the  State  law.  In  such  case  the  articles  of  association 
and  organization  certificate  may  be  executed  by  a  majority  of  the 
directors  of  the  bank  or  banking  institution,  and  the  certificate  shall 


388       OPERATION  OF  THE  NEW  BANK  ACT 

declare  tliat  tlic  owners  of  fifty-one  per  centum  of  the  capital  stock 
have  authorized  the  directors  to  make  such  certificate  and  to  change 
or  convert  the  bank  or  banking  institution  into  a  national  associa- 
tion. A  majority  of  the  directors,  after  executing  the  articles  of 
association  and  the  organization  certificate,  shall  have  power  to 
execute  all  other  papers  and  to  do  whatever  may  be  required  to 
make  its  organization  perfect  and  complete  as  a  national  association. 
The  shares  of  any  such  bank  may  continue  to  be  for  the  same  amount 
each  as  they  were  before  the  conversion,  and  the  directors  may  con- 
tinue to  be  directors  of  the  association  until  others  are  elected  or 
appointed  in  accordance  witli  the  provisions  of  the  statutes  of  the 
United  States.  When  the  Comptroller  has  given  to  such  bank  or 
banking  association  a  certificate  that  the  provisions  of  this  Act  have 
been  complied  with,  such  bank  or  banking  association,  and  all  its 
stockholders,  oflicers,  and  employees,  shall  have  the  same  powers  and 
privileges,  and  shall  be  subject  to  the  same  duties,  liabilities,  and 
regulations,  in  all  respects,  as  shall  have  been  prescribed  by  the 
Federal  Reserve  Act  and  by  the  national  banking  Act  for  associa- 
tions originally  organized  as  national  banking  associations. 

State  Banks  as  Members 

Sec.  9.  Any  bank  incorporated  by  special  law  of  any  State,  or 
organized  under  the  general  laws  of  any  State  or  of  the  United 
States,  may  make  application  to  the  reserve  bank  organization 
committee,  pending  organization,  and  thereafter  to  the  Federal 
Reserve  Board  for  the  right  to  subscribe  to  the  stock  of  the  Federal 
reserve  bank  organized  or  to  be  organized  within  the  Federal  reserve 
district  where  the  applicant  is  located.  The  organization  committee 
or  the  Federal  Reserve  Board,  under  such  rules  and  regulations  as 
it  may  prescribe,  subject  to  the  provisions  of  this  section,  may 
permit  the  applying  bank  to  become  a  stockholder  in  the  Federal 
reserve  bank  of  the  district  in  which  the  applying  bank  is  located. 
Whenever  the  organization  committee  or  the  Federal  Reserve  Board 
shall  permit  the  applying  bank  to  become  a  stockholder  in  the 
Federal  reserve  bank  of  the  district,  stock  shall  be  issued  and  paid 
for  under  the  rules  and  regulations  in  this  Act  provided  for 
national  banks  which  become  stockholders  in  Federal  reserve  banks. 

The  organization  committee  or  the  Federal  Reserve  Board  shall 
establish  by-laws  for  the  general  government  of  its  conduct  in  acting 
upon  applications  made  by  the  State  banks  and  banking  associations 
and  trust  companias  for  stock  ownership  in  Federal  reserve  banks. 
Such  by-laws  shall  require  applying  banks  not  organized  under 
Federal  law  to  comply  with  the  reserve  and  capital  requirements 
and  to  submit  to  the  examination  and  regulations  prescribed  by  the 
organization  committee  or  by  the  Federal  Reserve  Board.  No  ap- 
plying bank  shall  be  admitted  to  membership  in  a  Federal  reserve 
bank  unless  it  possesses  a  paid-up  unimpaired  capital  sufficient  to 
entitle  it  to  become  a  national  banking  association  in  the  place 
where  it  is  situated,  under  the  provisions  of  the  national  banking  Act. 

Any  bank  becoming  a  member  of  a  Federal  reser^-e  bank  under 
the  provisions  of  this  section  shall,  in  addition  to  the  regulations  and 
restrictions   hereinbefore   provided,   be   required    to   conform   to   the 


FEDERAL  RESERVE  ACT  389 

provisions  of  law  imposed  on  tbe  national  banks  respecting  the 
limitation  of  liability  which  may  be  incurred  by  any  person,  firm,  or 
corporation  to  sucli  banks,  tlie  prohibition  against  making  purchase 
of  or  loans  on  stock  of  such  banks,  and  tlie  withdrawal  or  impair- 
ment of  capital,  or  the  payment  of  unearned  dividends,  and  to  such 
rules  and  regulations  as  tiie  Federal  Reserve  Board  may,  in  pursu- 
ance thereof,  prescribe. 

Such  banks,  and  the  officers,  agents,  and  employees  thereof, 
shall  also  be  subject  to  the  provisions  of  and  to  the  penalties  pre- 
scribed by  sections  lifty-one  hundred  and  ninety-eight,  fifty-two 
hundred,  fifty-two  hundred  and  one,  and  fifty-two  hundred  and 
eight,  and  fifty-two  hundred  and  nine  of  the  Revised  Statutes.  The 
member  hanks  sliall  also  be  required  to  make  reports  of  tlie  condi- 
tions and  of  the  payments  of  dividends  to  the  Comptroller,  as  pro- 
vided in  sections  fifty-two  luuulred  and  eleven  and  fifty-two  iiundred 
and  twelve  of  the  Revised  Statutes,  and  sliall  be  subject  to  the 
penalties  prescribed  by  section  fifty-two  hundred  and  thirteen  for 
the  failure  to  make  such  report. 

If  at  any  time  it  shall  appear  to  the  Federal  Reserve  Board  that 
a  member  bank  has  failed  to  comply  with  the  provisions  of  this 
section  or  the  regulations  of  the  Federal  Reserve  Board,  it  shall  be 
within  the  power  of  the  said  board,  after  hearing,  to  require  such 
bank  to  surrender  its  stock  in  the  Federal  reserve  bank;  upon  such 
surrender  the  Federal  reserve  bank  shall  pay  the  cash-paid  subscrip- 
tions to  the  said  stock  with  interest  at  the  rate  of  one-half  of  one 
per  centum  per  month,  computed  from  the  last  dividend,  if  earned, 
not  to  exceed  the  book  value  thereof,  less  any  lial)ility  to  said 
Federal  reserve  bank,  except  the  subscription  liability  not  previously 
called,  which  shall  be  cancelled,  and  said  Federal  reserve  bank 
shall,  upon  notice  from  the  Federal  Reserve  Board,  be  required  to 
suspend  said  l)ank  from  furtlier  privileges  of  mombership,  and 
shall  within  tliirty  days  of  such  notice  cancel  and  retire  its  stock 
and  make  paj'ment  tlierefor  in  the  manner  herein  provided.  The 
Federal  Reserve  Board  may  restore  momliership  upon  due  proof  of 
compliance  with  tlie  conditions  imposed  liy  this  section. 

Federal  Reserve  Board 

Sec.  10.  A  Federal  Reserve  Board  is  hereby  created  which  shall 
consist  of  seven  members,  including  the  Secretary  of  the  Treasury 
and  the  Comptroller  of  the  Currency,  who  shall  be  members  ex- 
officio,  and  five  menil)ers  appointed  by  the  President  of  the  United 
States,  by  and  with  the  advice  and  consent  of  the  Senate.  In 
selecting  the  five  appointive  members  of  the  Federal  Reserve  Board, 
n<>t  more  than  one  of  whom  shall  be  selected  from  any  one  Federal 
reserve  district,  the  President  shall  have  due  regard  to  a  fair 
representation  of  the  different  commercial,  industrial  and  geographi- 
cal divisions  of  the  country.  The  five  memliers  of  the  Federal  Re- 
serve Board  appointed  by  the  President  and  confirmed  as  aforesaid 
shall  devote  their  entire  time  to  the  business  of  the  Federal  Reserve 
Board  and  shall  each  receive  an  annual  salary  of  .$12,000,  payable 
monthly  together  with  actual  necessary  traveling  expenses,  and 
the  Comptroller  of  the  Ciirrency,  as  ex-oftlcio  memlter  of  the  Federal 


390       OPERATION  OF  THE  NEW  BANK  ACT 

lieserve  Board,  sliall,  in  addition  to  the  salary  now  paid  him  as 
Comptroller  of  the  Currency,  receive  the  sum  of  $7,000  annually 
for  his  services  as  a  member  of  said  board. 

The  members  of  said  board,  the  Secretary  of  the  Treasury,  the 
Assistant  Secretaries  of  the  Treasury,  and  tlie  Comptroller  of  the 
Currency  shall  be  ineligible  during  the  time  they  are  in  office  and 
for  two  years  thereafter  to  hold  any  office,  position,  or  employment 
in  any  member  bank.  Of  the  five  members  thus  appointed  by  the 
President  at  least  two  shall  be  persons  experienced  in  banking  or 
finance.  One  shall  be  designated  by  the  President  to  serve  for  two, 
one  for  four,  one  for  six,  one  for  eight,  and  one  for  ten  years,  and 
thereafter  each  member  so  appointed  shall  serve  for  a  term  of  ten 
years  unless  sooner  removed  for  cause  by  the  President.  Of  the  five 
persons  thus  appointed,  one  shall  be  designated  by  the  President 
as  governor  and  one  as  vice-governor  of  the  Federal  Reserve  Board. 
The  governor  of  the  Federal  Reserve  Board,  subject  to  its  super- 
vision, shall  be  the  active  executive  officer.  The  Secretary  of  the 
Treasury  may  assign  offices  in  the  Department  of  the  Treasury  for 
the  use  of  the  Federal  Reserve  Board.  Each  member  of  the  Federal 
Reserve  Board  shall  within  fifteen  days  after  notice  of  appointment 
make  and  subscribe  to  the  oath  of  office. 

The  Federal  Reserve  Board  shall  have  power  to  levy  semi- 
annually upon  the  Federal  reserve  banks,  in  proportion  to  their 
capital  stock  and  surplus,  an  assessment  sufficient  to  pay  its  esti- 
mated expenses  and  the  salaries  of  its  members  and  employees  for 
the  half  year  succeeding  the  levying  of  such  assessment,  together 
with  any  deficit  carried  forward  from  the  preceding  half  year. 

The  first  meeting  of  the  Federal  Reserve  Board  shall  be  held  in 
Washington,  District  of  Columbia,  as  soon  as  may  be  after  the  pas- 
sage of  this  Act,  at  a  date  to  be  fixed  by  the  Reserve  Bank  Organiza- 
tion Committee.  The  Secretary  of  the  Treasury  shall  be  ex-officio 
chairman  of  the  Federal  Reserve  Board.  No  member  of  the  Federal 
Reserve  Board  shall  be  an  officer  or  director  of  any  bank,  banking 
institution,  trust  company,  or  Federal  reserve  bank  nor  hold  stock 
in  any  bank,  banking  institution,  or  trust  company;  and  before 
entering  upon  his  duties  as  a  member  of  the  Federal  Reserve  Board  he 
shall  certify  under  oath  to  the  Secretary  of  the  Treasury  that  he  has 
complied  with  this  requirement.  Whenever  a  vacancy  shall  occur, 
other  than  by  expiration  of  term,  among  the  five  members  of  the 
Federal  Reserve  Board  appointed  by  the  President,  as  above  pro- 
vided, a  successor  shall  be  appointed  by  the  President,  with  the 
advice  and  consent  of  the  Senate,  to  fill  such  vacancy,  and  when 
appointed  he  shall  hold  office  for  the  unexpired  term  of  the  member 
whose  place  he  is  selected  to  fill. 

The  President  shall  have  power  to  fill  all  vacancies  that  may 
happen  on  the  Federal  Reserve  Board  during  the  recess  of  the 
Senate,  by  granting  commissions  which  shall  expire  thirty  days  after 
the  next  session  of  the  Senate  convenes. 

Nothing  in  this  Act  contained  shall  be  construed  as  taking  away 
any  powers  heretofore  vested  by  law  in  the  Secretary  of  the  Treasury 
which  relate  to  the  supervision,  management,  and  control  of  the 
Treasury    Department    and    bureaus    under    such    department,    and 


FEDERAL  RESERVE  ACT  391 

wherever  any  power  vested  by  this  Act  in  the  Federal  Reserve  Board 
or  tlie  Federal  reserve  agent  appears  to  conflict  with  the  powers  of 
the  Secretary  of  the  Treasury,  sucli  powers  shall  be  exercised  sub- 
ject to  the  supervision  and  control  of  the  Secretary. 

The  Federal  Reserve  Board  shall  annually  make  a  full  report  of 
its  operations  to  the  Speaker  of  the  House  of  Representatives,  who 
shall  cause  the  same  to  be  printed  for  tlie  information  of  the 
Congress. 

Section  three  hundred  and  twenty-four  of  tlie  Revised  Statutes 
of  the  United  States  shall  be  amended  so  as  to  read  as  follows: 
There  shall  be  in  the  Department  of  the  Treasury  a  bureau  charged 
with  the  execution  of  all  laws  passed  by  Congress  relating  to  the 
issue  and  regulation  of  national  currency  secured  by  United  States 
bonds  and,  under  the  general  supervision  of  tlie  Federal  Rosorve 
Board,  of  all  Federal  reserve  notes,  the  chief  officer  of  which  bureau 
shall  he  called  the  Comptroller  of  the  Currency  and  sliall  perform  his 
duties  under  the  general  directions  of  the  Secretary  of  tlie  Treasury. 

Sec.  11.  The  Federal  Reserve  Board  shall  be  authorized  and 
empowered: 

(a)  To  examine  at  its  discretion  the  accounts,  books  and  affairs 
of  each  Federal  reserve  bank  and  of  each  member  bank  and  to  re- 
quire such  statements  and  reports  as  it  may  deem  necessary.  The 
said  board  shall  publish  once  each  week  a  statement  showing  the 
condition  of  each  Federal  reserve  bank  and  a  consolidated  statement 
for  all  Federal  reserve  banks.  Such  statements  shall  show  in  detail 
the  assets  and  liabilities  of  the  Federal  reserve  banks,  single  and 
combined,  and  shall  furnish  full  information  regarding  the  char- 
acter of  the  money  held  as  reserve  and  the  amount,  nature  and 
maturities  of  the  paper  and  other  investments  owned  or  held  by 
Federal   reserve   banks. 

(b)  To  permit,  or.  on  the  affirmative  vote  of  at  least  five 
members  of  the  Reserve  Board  to  require  Federal  reserve  banks  to 
rediscount  the  discounted  paper  of  other  Fedora!  reservG  l)anks  at 
rates  of  interest  to  be  fixed  by  the  Federal  Reserve  Board. 

(c)  To  suspend,  for  a  period  not  exceeding  thirfy  days,  and 
from  time  to  time  to  renew  such  suspension  for  periods  not  exceeding 
fifteen  days,  any  reserve  requirement  specified  in  this  Act:  Pro- 
vided, That  it  shall  establish  a  graduated  tax  upon  the  amounts  by 
which  the  reserve  requirements  of  this  Act  may  l)o  permitted  to  fall 
below  the  level  hereinafter  specified:  .\y\d  provided  further.  That 
when  the  gold  reserve  held  against  Federal  reserve  notes  falls  below 
forty  per  centum,  the  Federal  Reserve  Board  shall  establish  a 
graduated  tax  of  not  more  than  one  per  centum  per  annum  upon 
such  deficiency  until  the  reserves  fall  to  thirty-two  and  one  half 
per  centum,  and  when  said  reserve  falls  below  thirty-two  and  one-half 
per  centum,  a  tax  at  the  rate  increasingly  of  not  less  than  one  and 
one-half  per  centum  per  annum  uyion  each  two  and  one-half  per 
centum  or  fraction  thereof  that  such  reserve  falls  below  thirty-two 
and  one-half  per  centum.  The  tax  shall  Ite  paid  by  the  resorve  bank, 
but  the  reserve  bank  shall  add  an  amount  equal  to  said  tax  to  the 
rates  of  interest  and  discount  fixed  by  the  Federal   Reser^-e  Board. 

(d)  To  supervise  and  regulate  through  the   biiroau  under  the 


39!2       OrERATlON  OF  THE  NEW  BANK  ACT 

charge  of  the  Comptroller  of  the  Currency  the  issue  and  retirement 
of  Federal  reserve  notes,  and  to  prescribe  rules  and  regulations  under 
which  such  notes  may  be  delivered  by  the  Comptroller  to  the  Federal 
reserve  agents  applying  therefor. 

(e)  To  add  to  the  number  of  cities  classified  as  reserve  and 
central  reserve  cities  under  existing  law  in  whicii  national  banking 
associations  are  subject  to  the  reserve  requirements  set  forth  in 
section  twenty  of  this  Act;  or  to  reclassify  existing  reserve  and 
central  reserve  cities  or  to  terminate  their  designation  as  such. 

(f)  To  suspend  or  remove  any  officer  or  director  of  any  Federal 
reserve  bank,  the  cause  of  such  removal  to  be  forthwitli  communi- 
cated in  writing  by  the  Federal  Reserve  Board  to  the  removed 
officer  or  director  and  to  said  bank. 

(g)  To  require  the  writing  oflf  of  doubtful  or  worthless  assets 
upon  the  books  and  balance  sheets  of  Federal  reserve  banks. 

(h)  To  suspend,  for  the  violation  of  any  of  the  provisions  of 
this  Act,  the  operations  of  any  Federal  reserve  bank,  to  take  posses- 
sion thereof,  administer  the  same  during  the  period  of  suspension, 
and,  when  deemed  advisable,  to  liquidate  or  reorganize  such  bank. 

(i)  To  require  bonds  of  Federal  reserve  agents,  to  make  regula- 
tions for  the  safeguarding  of  all  collateral,  bonds.  Federal  reserve 
notes,  money  or  property  of  any  kind  deposited  in  the  hands  of  such 
agents,  and  said  board  shall  perform  the  duties,  functions,  or  ser- 
vices specified  in  this  Act  and  make  all  rules  and  regulations 
necessary  to  enable  said  board  eflfectively  to  perform  the  same. 

(j)  To  exercise  general  supervision  over  said  Federal  reserve 
banks. 

(k)  To  grant  by  special  permit  to  national  banks  applying 
therefor,  when  not  in  contravention  of  State  or  local  law,  the  right 
to  act  as  trustee,  executor,  administrator,  or  registrar  of  stocks 
and  bonds  under  such  rules  and  regulations  as  the  said  board  may 
prescribe. 

(1)  To  employ  such  attorneys,  experts,  assistants,  clerks,  or 
other  employees  as  may  be  deemed  necessary  to  conduct  the  business 
of  the  board.  All  salaries  and  fees  shall  be  fixed  in  advance  by 
said  board  and  shall  be  paid  in  the  same  manner  as  the  salaries  of 
the  members  of  said  board.  All  such  attorneys,  experts,  assistants, 
clerks,  and  other  employees  shall  be  appointed  without  regard  to  the 
provisions  of  the  Act  of  January  sixteenth,  eighteen  hundred  and 
eighty-three  (volume  twenty-two,  United  States  Statutes  at  Large, 
page  four  hundred  and  three),  and  amendments  thereto,  or  any  rule 
or  regulation  made  in  pursuance  thereof:  Provided.  That  nothing 
herein  shall  prevent  the  President  from  placing  said  employees  in 
the  classified  service. 

Federal  Advisory  Council 

Sec.  12.  There  is  hereby  created  a  Federal  Advisory  Council, 
which  shall  consist  of  as  many  members  as  there  are  Federal  reserve 
districts.  Each  Federal  reserve  bank  by  its  board  of  directors  shall 
annually  select  from  its  own  Federal  reserve  district  one  member  of 
said  council,  who  shall  receive  such  compensation  and  allowances  as 
may  be  fixed  by  his  board  of  directors  subject  to  the  approval  of  the 


FEDERAL  RESERVE  ACT  393 

Federal  Keserve  Board.  The  meetings  of  said  advisory  council  shall 
be  held  at  Wasliington,  District  of  Columbia,  at  least  four  times 
each  year,  and  oftener  if  called  by  tlie  Federal  Reserve  Board.  The 
council  may,  in  addition  to  the  meetings  above  provided  for,  hold  such 
other  meetings  in  Wasliington,  District  of  Columbia,  or  elsewhere, 
as  it  may  deem  necessary,  may  select  its  own  oflicers  and  adopt  its 
own  metiiods  of  procedure,  and  a  majority  of  its  members  sliall  con- 
stitute a  quorum  for  tlie  transaction  of  business.  Vacancies  in  the 
council  shall  be  filled  by  tlie  respective  reserve  banks,  and  members 
selected  to  lill  vacancies  shall  serve  for  the  unexpired  term. 

The  Federal  Advisory  Council  shall  have  power,  by  itself  or 
through  its  oflicers,  (1)  to  confer  directly  with  the  Federal  Reserve 
Board  on  general  business  conditions;  (2)  to  make  oral  or  written 
representations  concerning  matters  witliin  the  jurisdiction  of  said 
ijoard;  (3)  to  call  for  information  and  to  make  recommendations  in 
regard  to  discount  rates,  rediscount  business,  note  issues,  reserve 
conditions  in  the  various  districts,  the  purchase  and  sale  of  gold  or 
securities  by  reserve  banks,  open-market  operations  by  said  banks, 
and  the  general  affairs  of  the  reserve  banking  system. 

Powers  of  Federal  Reserve  Banks 

Sec.  1.3.  Any  Federal  reserve  bank  may  receive  from  any  of  its 
member  banks,  and  from  the  United  States,  deposits  of  current  funds 
in  lawful  money,  national-bank  notes.  Federal  reserve  notes,  or 
checks  and  drafts  >ipon  solvent  member  banks,  payable  upon  presen- 
tation; or,  solely  for  exchange  purposes,  may  receive  from  other 
Federal  reserve  banks  deposits  of  current  funds  in  lawful  money, 
national-bank  notes,  or  checks  and  drafts  upon  solvent  member  or 
otlier  Federal  reserve  banks,  payable  upon  presentation. 

Upon  the  indorsement  of  any  of  its  member  banks,  with  a  waiver 
of  demand,  notice  and  protest  Ity  such  bank,  any  Federal  reserve 
bank  may  discount  notes,  drafts,  and  bills  of  exchange  arising  out  of 
actual  commercial  transactions:  tliat  is,  notes,  drafts,  and  bills  of 
exchange  issued  or  drawn  for  agricultural,  industrial,  or  commercial 
purposes,  or  the  proceeds  of  whicli  have  been  tised,  or  are  to  be  used, 
for  such  purposes,  the  Federal  Reserve  Board  to  have  the  right  to 
determine  or  define  the  character  of  the  paper  thus  eligible  for  dis- 
count, within  the  meaning  of  this  Act.  Nothing  in  this  Act  con- 
tained shall  be  construed  to  prohibit  such  notes,  drafts,  and  bills  of 
exchange,  secured  by  staple  agricultural  products,  or  other  goods. 
wares,  or  merchandise  froiTi  being  eligible  for  such  discount  :  Imt  such 
definition  shall  not  include  notes,  drafts,  or  bills  covering  merely 
investments  or  issued  or  drawn  for  tlie  purpose  of  carrying  or  trad- 
ing in  stocks,  bonds,  or  other  investment  securities,  except  bonds  and 
notes  of  the  CJovernment  of  the  United  States.  Notes,  drafts,  and 
bills  admitted  to  discount  under  the  terms  of  this  paragraph  mu«t 
have  a  maturity  at  the  time  of  discount  of  not  more  than  ninety 
days:  Provided,  That  notes,  drafts,  and  bills  drawn  or  issued  for 
agricultural  purpo'^cs  or  based  on  live  stock  and  having  a  maturity 
not  exceeding  six  nionths  may  be  discounted  in  an  ninount  to  be 
limited  to  a  percentage  of  the  capital  of  the  Federal  reserve  bank, 
to  lie  ascertained  and  fixed  by  the  Federal  Reserve  Board. 


394      OPERATION  OF  THE  NEW  BANK  ACT 

Any  Federal  reserve  bank  may  discount  acceptances  which  arc 
based  on  the  importation  or  exportation  of  goods  and  which  have 
a  maturity  at  time  of  discount  of  not  more  than  three  months,  and 
indorsed  by  at  least  one  member  bank.  The  amount  of  acceptances 
so  discounted  shall  at  no  time  exceed  one-half  the  paid-up  capital 
stock  and  surplus  of  Die  bank  for  which  the  rediscounts  are  made. 

Tlie  aggregate  of  sucli  notes  and  bills  bearing  the  signature  or  in- 
dorsement of  any  one  person,  company,  firm,  or  corporation  redis- 
counted  for  any  one  bank  shall  at  no  time  exceed  ten  per  centum  of 
the  unimpaired  capital  and  surplus  of  said  bank;  but  this  restriction 
shall  not  apply  to  the  discount  of  bills  of  exchange  drawn  in  good 
faith  against  actually  existing  values. 

Any  member  bank  may  accept  drafts  or  bills  of  exchange  drawn 
upon  it  and  growing  out  of  transactions  involving  the  importation 
or  exportation  of  goods  having  not  more  than  six  months'  sight  to 
run;  but  no  bank  shall  accept  such  bills  to  an  amount  equal  at 
any  time  in  the  aggregate  to  more  than  one-half  its  paid-up  capital 
stock  and  surplus. 

Section  fifty-two  hundred  and  two  of  the  Revised  Statutes  of  the 
United  States  is  here1)y  amended  so  as  to  read  as  follows:  No 
national  banking  association  shall  at  any  time  be  indebted,  or  in 
any  way  liable,  to  an  amount  exceeding  the  amount  of  its  capital 
stock  at  such  time  actually  paid  in  and  remaining  undiminished  by 
losses  or  otherwise,  except  on  account  of  demands  of  the  nature 
following: 

First.     Notes  of  circulation. 

Second.   Moneys  deposited  with  or  collected  by  the  association. 

Third.  Bills  of  exchange  or  drafts  drawn  against  money  actually 
on  deposit  to  the  credit  of  the  association,  or  due  thereto. 

Fourth.  Liabilities  to  the  stockholders  of  the  association  for 
dividends  and  reserve  profits. 

Fifth.  Liabilities  incurred  under  the  provisions  of  the  Federal 
Reserve  Act. 

The  rediscount  by  any  Federal  reserve  bank  of  any  bills  re- 
ceivable and  of  domestic  and  foreign  bills  of  exchange,  and  of 
acceptances  authorized  by  this  Act,  shall  be  subject  to  such  re- 
strictions, limitations,  and  regulations  as  may  be  imposed  by  the 
Federal  Reserve  Board. 

Open-market  Operations 

Sec.  14.  Any  Federal  reserve  bank  may,  under  rules  and  regiila- 
tions  prescribed  by  the  Federal  Reserve  Board,  purchase  and  sell  in 
the  open  market,  at  home  or  abroad,  either  from  or  to  domestic  or 
foreign  banks,  firms,  corporations,  or  individuals,  cable  transfers  and 
bankers'  acceptances  and  bills  of  exchange  of  the  kinds  and  ma- 
turities by  this  Act  made  eligible  for  rediscount,  with  or  without 
the  indorsements  of  a  member  bank. 

Every  Federal  reserve  bank  shall  have  power: 

(a)     To  deal  in  gold  coin   and  bullion  at  home  or  abroad,  to 

make  loans  thereon,  exchange  Federal   reserve  notes  for  gold,  gold 

coin,  or  gold  certificates,  and  to  contract  for  loans  of  gold  coin  or 

bullion,  giving  therefor,  when  necessary,  acceptable  security,  includ- 


FEDERAL  RESERVE  ACT  395 

ing  the   hypothecation  of    United   States  bonds  or  other  securities 
which  Federal  reserve  banks  are  authorized  to  hold; 

(b)  To  buy  and  sell,  at  home  or  abroad,  bonds  and  notes  of  tho 
United  States,  and  bills,  notes,  revenue  bonds,  and  warrants  with  a 
maturity  from  date  of  purchase  of  not  exceeding  six  months,  issued 
in  anticipation  of  the  collection  of  taxes  or  in  anticipation  of  the 
receipt  of  assured  revenues  by  any  State,  county,  district,  political 
subdivision,  or  municipality  in  the  continental  United  States,  in- 
cluding irrigation,  drainage  and  reclamation  districts,  sudi  pur- 
chases to  be  made  in  accordance  witii  rules  and  regulations  pre- 
scribed by  the  Federal  Reserve  Hoard; 

(c)  To  purchase  from  member  banks  and  to  sell,  with  or  with- 
out its  indorsement,  bills  of  exchange  arising  out  of  commercial 
transactions,  as  hereinbefore  defined; 

(d)  To  establish  from  time  to  time,  subject  to  review  and 
determination  of  the  Federal  Reserve  Board,  rates  of  discount  to  be 
charged  by  the  Federal  reserve  bank  for  each  class  of  paper,  which 
shall  be  fixed  with  a  view  of  accommodating  cdmimTte  and  business; 

(e)  To  establish  accounts  with  other  Federal  reserve  banks  for 
exchange  purposes  and,  with  the  consent  of  the  Federal  Reserve 
Hoard,  to  open  and  maintain  banking  accounts  in  foreign  countries, 
appoint  correspondents,  and  estiiblish  agencies  in  such  countries 
wlieresoever  it  may  deem  best  for  the  purpose  of  ])urchasing.  selling, 
and  collecting  bills  of  exchange,  and  to  buy  and  sell  with  or  without 
its  indorsement,  through  such  correspondents  or  agencies,  bills  of 
exchange  arising  out  of  actual  commercial  transactions  which  have 
not  more  than  ninety  days  to  rim  and  which  bear  the  signature  of 
two  or  more  responsible  parties. 

Government  Deposits 

Sec.  15.  The  moneys  held  in  the  general  fund  of  the  Treasury, 
except  the  five  per  centum  fund  for  the  redemption  of  outstanding 
national-bank  notes  and  the  funds  provided  in  this  Act  for  the  re- 
demption of  Federal  reserve  notes  may,  upon  the  direction  of  the 
Secretary  of  the  Treasury,  be  deposited  in  Federal  reserve  banks, 
wliich  banks,  when  refpiired  by  the  Secretary  of  the  Treasury,  shall 
act  as  fiscal  agents  of  the  United  States;  and  the  revenues  of  the 
Government  or  any  part  thereof  may  be  dt'|)o-;ite(l  in  such  baiiks, 
and  disbursements  may  be  made  by  checks  drawn  against  such 
deposits. 

No  public  funds  of  the  Philippine  Islands,  or  of  the  postal  sav- 
ings, or  any  (lovorninent  funds,  shall  be  depositeil  in  the  continental 
United  States  in  any  bank  not  l)plonging  to  the  system  established 
by  this  Act:  Provided,  however.  That  nothing  in  this  Act  shall  be 
con.strued  to  deny  the  right  of  the  Secretary  of  the  Treasury  to  use 
member  banks  as  depositaries. 

Note  Issues 

Sec.  10.  Federal  reserve  notes,  to  lie  issued  at  the  discretion  of 
the  Federal  Reserve  Board  for  the  purpose  of  nuiking  advances  to 
Federal  reserve  banks  through  the  Federal  reserve  agents  as  here- 
inafter set  forth  and   for  no  other  purpose,  are   lierel>y  authorized. 


396       OPERATION  OF  THE  NEW  BANK  ACT 

The  said  notes  shall  be  obligations  of  the  United  States  and  shall 
be  receivable  by  all  national  and  member  banks  and  Federal  reserve 
banks  and  for  all  taxes,  customs,  and  other  public  dues.  They  shall 
be  redeemed  in  gold  on  demand  at  the  Treasury  Department  of  the 
United  States,  in  the  city  of  Washington,  District  of  Columbia,  or 
in  gold  or  lawful  money  at  any  Federal  reserve  bank. 

Any  Federal  reserve  bank  may  make  application  to  the  local 
Federal  reserve  agent  for  such  amount  of  the  Federal  reserve  notes 
hereinbefore  provided  for  as  it  may  require.  Such  application  shall 
be  accompanied  with  a  tender  to  the  local  Federal  reserve  agent  of 
collateral  in  amount  equal  to  the  sum  of  the  Federal  reserve  notes 
thus  applied  for  and  issued  pursuant  to  such  application.  The 
collateral  security  thus  offered  shall  be  notes  and  bills,  accepted  for 
rediscount  under  the  provisions  of  section  thirteen  of  this  Act,  and 
the  Federal  reserve  agent  shall  each  day  notify  the  Federal  Reserve 
Board  of  all  issues  and  withdrawals  of  Federal  reserve  notes  to  and 
by  the  Federal  reserve  bank  to  which  he  is  accredited.  The  said 
Federal  Reserve  Board  may  at  any  time  call  upon  a  Federal  reserve 
bank  for  additional  security  to  protect  the  Federal  reserve  notes 
issued  to  it. 

Every  Federal  reserve  bank  shall  maintain  reserves  in  gold  or 
lawful  money  of  not  less  than  thirty-five  per  centum  against  its 
deposits  and  reserves  in  gold  of  not  less  than  forty  per  centum 
against  its  Federal  reserve  notes  in  actual  circulation,  and  not 
offset  by  gold  or  lawful  money  deposited  with  the  Federal  reserve 
agent.  Notes  so  paid  out  shall  bear  upon  their  faces  a  distinctive 
letter  and  serial  niimber,  which  shall  be  assigned  by  the  Federal 
Reserve  Board  to  each  Federal  reserve  bank.  Whenever  Federal 
reserve  notes  issued  through  one  Federal  reserve  bank  shall  be  re- 
ceived by  another  Federal  reserve  bank  they  shall  be  promptly 
returned  for  credit  or  redemption  to  the  Federal  reserve  bank 
through  which  they  were  originally  issued.  No  Federal  reserve 
bank  shall  pay  out  notes  issued  through  another  under  penalty  of  a 
tax  of  ten  per  centum  upon  the  face  value  of  notes  so  paid  out. 
Notes  presented  for  redemption  at  the  Treasury  of  the  United  States 
shall  be  paid  out  of  the  redemption  fund  and  returned  to  the  Federal 
reserve  banks  through  which  they  were  originally  issued,  and  there- 
upon such  Federal  reserve  bank  shall,  upon  demand  of  the  Secretary 
of  the  Treasury,  reimburse  such  redemption  fund  in  lawful  money 
or,  if  such  Federal  reserve  notes  have  been  redeemed  by  the  Treasurer 
in  gold  or  gold  certificates,  then  such  funds  shall  be  reimbursed  to 
the  extent  deemed  necessary  by  the  Secretary  of  the  Treasury  in  gold 
or  gold  certificates,  and  such  Federal  reserve  bank  shall,  so  long  as 
any  of  its  Federal  reserve  notes  remain  outstanding,  maintain  with 
the  Treasurer  in  gold  an  amount  sufficient  in  the  judgment  of  the 
Secretary  to  provide  for  all  redemptions  to  be  made  by  the  Treasurer. 
Federal  reserve  notes  received  by  the  Treasury,  otherwise  than  for 
redemption,  may  be  exchanged  for  gold  out  of  the  redemption  fund 
hereinafter  provided  and  returned  to  the  reserve  bank  through  which 
they  were  originally  issued,  or  they  may  be  returned  to  such  bank 
for  the  credit  of  the  United  States.  Federal  reserve  notes  unfit  for 
circulation  shall  be  returned  by  the  Federal  reserve  agents  to  the 
Comptroller  of  the  Currency  for  cancellation  and  destruction. 


FEDERAL  RESERVE  ACT  397 

The  Feileral  Reserve  Board  sliall  require  each  Federal  reserve 
bank  to  maintain  on  deposit  in  the  Treasury  of  tlie  United  States 
a  sum  in  gold  sullicient  in  tlie  judp^ment  of  the  Secretary  of  the 
Treasury  for  the  redemption  of  the  Federal  reserve  notes  issued  to 
such  bani<,  but  in  no  event  less  tiian  five  per  centum  :  but  such  de- 
posit of  gold  shall  be  counted  and  included  as  part  of  the  forty  per 
centuju  reserve  hereinbefore  required.  The  board  shall  have  the 
right,  acting  through  the  Federal  reserve  agent,  to  grant  in  whole 
or  in  part  or  to  reject  entirely  the  application  of  any  Federal 
leserve  bank  for  Federal  reserve  notes;  but  to  the  extent  that  such 
application  may  be  granted  the  Federal  Reserve  Board  shall,  through 
its  local  Federal  reserve  agent,  supply  Federal  reserve  notes  to  the 
bank  so  applj'ing,  and  such  bank  shall  be  charged  with  the  amount 
of  such  notes  and  shall  pay  such  rate  of  interest  on  said  amount  as 
may  be  established  by  the  Federal  Reserve  Board,  and  the  amount  of 
such  Federal  reserve  notes  so  issued  to  any  such  bank  shall,  upon 
delivery,  together  with  such  liotes  of  such  Federal  reserve  bank  as 
may  be  issued  under  section  eighteen  of  this  Act  upon  security  of 
United  States  two  per  centum  Government  bonds,  become  a  first  and 
paramount  lien  on  all  the  assets  of  such  bank. 

Any  Federal  reserve  bank  may  at  any  time  reduce  its  liability 
for  outstanding  Federal  reserve  notes  by  depositing,  with  the  Federal 
reserve  agent,  its  Federal  reserve  notes,  gold,  gold  certificates,  or 
lawful  money  of  the  United  States.  Federal  reserve  notes  so  de- 
l)osited  shall  not  be  reissued,  except  upon  compliance  with  the 
conditions  of  an  original  issue. 

The  Federal  reserve  agent  shall  hold  such  gold,  gold  certificates, 
or  lawful  money  available  exclusively  for  exchange  for  the  outstand- 
ing Federal  reserve  notes  when  olTered  by  the  reserve  bank  of  which 
he  is  a  director.  Upon  the  request  of  the  Secretary  of  the  Treasury 
the  Federal  Reserve  Board  shall  require  the  Federal  reserve  agent 
to  transmit  so  much  of  said  gold  to  the  Treasury  of  the  United  States 
as  may  be  required  for  the  exclusive  purpose  of  the  redemption  of 
such  notes. 

Any  Federal  reserve  bank  may  at  its  discretion  withdraw 
collateral  deposited  with  the  local  Federal  reserve  agent  for  the 
protection  of  its  Federal  reserve  notes  deposited  with  it  and  shall 
at  the  same  time  substitute  therefor  other  like  collateral  of  equal 
amount  with  the  approval  of  the  Federal  reserve  agent  under  regula- 
tions to  be  prescribed  by  tlie  Federal  Reserve  Board. 

In  order  to  furnisli  suitable  notes  for  circulation  as  Federal  re- 
serve notes,  the  Comptroller  of  the  Currency  shall,  under  the  direc- 
tion of  the  Secretary  of  the  Treasury,  cause  plates  and  dies  to  be 
engraved  in  the  best  manner  to  guard  against  ro\interfeits  and 
fraudulent  alterations,  and  shall  have  printed  therefrom  and 
numbered  sucli  qunntities  of  such  notes  of  the  denominations  of 
.$.').  .$10,  .$20.  $.")0.  $100.  as  may  be  required  to  supi)ly  the  Federal 
reserve  banks.  Such  notes  shall  be  in  form  and  tenor  as  directed 
by  the  Secretary  of  the  Treasury  under  the  provisions  of  this  Act 
and  shall  bear  the  distinctive  numbers  of  the  several  Federal  reserve 
l)anks  through   which  they  are   issnod. 

Wlien  such  notes  have  been  ]>repared,  they  shall  be  dejiosiled  in 
the  Treasury,  or   in  the  subtreasury  or  mint  of  the  United   States 


398      OPERATION  OF  THE  NEW  BANK  ACT 

nearest  the  place  of  business  of  each  Federal  reserve  bank  and  shall 
be  held  for  tlie  use  of  such  bank  subject  to  the  order  of  the  Comp- 
troller of  the  Currency  for  their  delivery,  as  provided  by  this  Act. 

The  plates  and  dies  to  be  procured  by  tlie  Comptroller  of  the 
Currency  for  the  printing  of  sucli  circulating  notes  shall  remain 
under  his  control  and  direction,  and  the  expenses  necessarily  incurred 
in  executing  the  laws  relating  to  the  procuring  of  such  notes,  and  all 
other  expenses  incidental  to  their  issue  and  retirement,  siiall  be  paid 
by  the  Federal  reserve  banks,  and  the  Federal  Reserve  Board  shall 
include  in  its  estimate  of  expenses  levied  against  the  Federal  reserve 
banks  a  sufficient  amount  to  cover  the  expenses  herein  provided  for. 

The  examination  of  plates,  dies,  bed  pieces,  and  so  forth,  and 
regulations  relating  to  such  examination  of  plates,  dies,  and  so  forth, 
of  national-bank  notes  provided  for  in  section  fifty-one  hundred  and 
seventy-four.  Revised  Statutes,  is  hereby  extended  to  include  notes 
herein  provided  for. 

Any  appropriation  heretofore  made  out  of  the  general  funds  of 
the  Treasury  for  engraving  plates  and  dies,  the  purchase  of  distinc- 
tive paper,  or  to  cover  any  other  expense  in  connection  with  the 
printing  of  national-bank  notes  or  notes  provided  for  by  the  Act  of 
May  thirtieth,  nineteen  hundred  and  eight,  and  any  distinctive  paper 
that  may  be  on  hand  at  the  time  of  the  passage  of  this  Act  may  be 
vised  in  the  discretion  of  the  Secretary  for  the  purposes  of  this  Act. 
and  should  the  appropriations  heretofore  made  be  insufficient  to 
meet  the  requirements  of  this  Act  in  addition  to  circulating  notes 
provided  for  by  existing  law,  the  Secretary  is  hereby  authorized  to 
use  so  much  of  any  funds  in  the  Treasury  not  otherwise  appro- 
priated for  the  purpose  of  furnishing  the  notes  aforesaid:  Provided, 
however,  That  nothing  in  this  section  contained  shall  be  construed 
as  exempting  national  banks  or  Federal  reserve  banks  from  their 
liability  to  reimburse  the  United  States  for  any  expenses  incurred 
in  printing  and  issuing  circulating  notes. 

Every  Federal  reserve  bank  shall  receive  on  deposit  at  par  from 
member  banks  or  from  Federal  reserve  banks  checks  and  drafts 
drawn  upon  any  of  its  depositors,  and  when  remitted  by  a  Federal 
reserve  bank,  checks  and  drafts  drawn  by  any  depositor  in  any  other 
Federal  reserve  bank  or  member  bank  upon  funds  to  the  credit  of 
said  depositor  in  said  reserve  bank  or  member  bank.  Nothing  herein 
contained  shall  be  construed  as  prohibiting  a  member  bank  from 
charging  its  actual  expense  incurred  in  collecting  and  remitting 
funds,  or  for  exchange  sold  to  its  patrons.  The  Federal  Reserve 
Board  shall,  by  rule,  fix  the  charges  to  be  collected  by  the  member 
banks  from  its"  patrons  whose  checks  are  cleared  through  the  Federal 
reserve  bank  and  the  charge  which  may  be  imposed  for  the  service 
of  clearing  or  collection  rendered  by  the  Federal  resen-e  bank. 

The  Federal  Reserve  Board  shall  make  and  promulgate  from 
time  to  time  regulations  governing  the  transfer  of  funds  and  charges 
therefor  among  Federal  reserve  banks  and  their  branches,  and  may 
at  its  discretion  exercise  the  functions  of  a  clearing  house  for  such 
Federal  reserve  banks,  or  may  designate  a  Federal  reserve  bank  to 
exercise  such  functions,  and  may  also  require  each  such  bank  to 
exercise  the  functions  of  a  clearing  house  for  its  member  banks. 

Sec.  17.    So  much  of  the  provisions  of  section  fifty-one  hundred 


FEDERAL  RESERVE  ACT  399 

and  lifty-nine  of  the  Kevised  Statutes  of  the  United  States,  and 
section  four  of  tiie  Act  of  June  twentieth,  eighteen  hundred  and 
seventy-four,  and  section  eight  of  the  Act  of  July  twelfth,  eighteen 
hundred  and  eighty-two,  and  of  any  other  provisions  of  existing 
statutes  as  require  tiiat  before  any  national  banking  association 
shall  be  authorized  to  commence  banking  business  it  shall  transfer 
and  deliver  to  the  Treasurer  of  the  United  States  a  stated  amount  of 
United  States  registered  bonds  is  hereby  repealed. 

Refunding  Bonds 

Sec.  18.  After  two  years  from  the  passage  of  this  Act,  and  at 
any  time  during  a  period  of  twenty  years  thereafter,  any  member 
bank  desiring  to  retire  tiie  whole  or  any  part  of  its  circulating  notes, 
may  lile  with  tlie  Treasurer  of  the  United  States  an  application  to 
sell  for  its  account,  at  i)ar  and  accrued  interest,  United  States  bonds 
securing  circulation  to  be  retired. 

The  Treasurer  sliall,  at  tiie  end  of  each  quarterly  period,  furnisli 
the  Federal  Reserve  Board  with  a  list  of  such  applications,  and  the 
Federal  Reserve  Board  may,  in  its  discretion,  require  the  Federal 
reserve  banks  to  purchase  such  bonds  from  the  banks  whose  appli- 
cations have  been  filed  with  the  Treasurer  at  least  ten  days  before 
the  end  of  any  quarterly  period  at  which  the  Federal  Reserve  Board 
may  direct  the  purchase  to  be  made:  Provided,  That  Federal  reserve 
banks  shall  not  be  permitted  to  purchase  an  amount  to  exceed 
$25,000,000  of  such  bonds  in  any  one  year,  and  wiiich  amount  shall 
include  bonds  acquired  under  section  four  of  this  Act  by  the  Federal 
reserve  bank. 

Provided  further,  That  the  Federal  Reserve  Board  shall  allot  to 
each  Federal  reserve  bank  such  proportion  of  such  bonds  as  tlie 
capital  and  surplus  of  such  bank  shall  bear  to  the  aggregate  capital 
and  surplus  of  all  the  Federal  reserve  l)aiiks. 

Upon  notice  from  the  Treasurer  of  the  amount  of  bonds  so  sold 
for  its  account,  each  member  bank  sliall  duly  assign  and  transfer, 
in  writing,  such  bonds  to  the  Federal  reserve  bank  purdiasing  the 
same,  and  such  Federal  reserve  bank  shall,  thcreu|)on.  deposit  lawful 
money  with  tlie  Treasurer  of  the  United  States  for  the  purchase  price 
of  such  bonds,  and  the  Treasurer  shall  jiay  to  the  member  iumk 
selling  such  bonds  any  balance  due  after  deducting  a  sulliiiont  sum 
to  redeem  its  outstanding  notes  secured  by  such  bonds,  which  notes 
shall  be  cancelled  and  permanently  retired  wlien  redeemed. 

The  Federal  reserve  banks  purchasing  such  bonds  shall  be  per- 
mitted to  take  out  an  amount  of  circulating  notes  equal  to  the  par 
value  of  such   bonds. 

Upon  tlie  deposit  with  the  Treasurer  of  tiie  United  States  of 
bonds  so  purchased,  or  any  bonds  with  the  circulating  privilege 
acquired  under  section  four  of  tliis  Act.  any  Federal  reserve  bank 
making  such  deposit  in  the  manner  provided  i)y  existing  law.  siiall 
be  entitled  to  receive  from  the  Comptroller  of  the  Currency  circulat- 
ing notes  in  blank,  registered  and  countersigned  as  provided  by  law, 
equal  in  amount  to  the  par  value  of  the  bonds  so  deposited.  Such 
notes  shall  be  the  obligations  of  the  Federal  reserve  bank  procuring 
the  same,  and  shall  be  in  form  prescribed  by  the  Secretary  of  the 


400       OPERATION  OF  THE  NEW  BANK  ACT 

Treasury,  and  to  tiie  .same  tenor  and  elleet  as  niitional-l>ank  notes 
now  provided  by  law.  They  sliall  be  issued  and  redeemed  under  the 
same  terms  and  conditions  as  national-bank  notes  except  that  thev 
shall  not  be  limited  to  the  amount  of  the  capital  stock  of  the  Federa'l 
reserve  bank  issuing  them. 

Upon  application  of  any  Federal  reserve  bank,  approved  by  the 
Federal  Reserve  Board,  the  Secretary  of  the  Treasury  may  issue,  in 
exchange  for  United  States  two  per  centum  gold  bonds  bearing  the 
circulation  privilege,  but  against  which  no  circulation  is  outstanding, 
one-year  gold  notes  of  the  United  States  without  tiie  circulation 
privilege,  to  an  amount  not  to  exceed  one-half  of  the  two  per  centum 
bonds  so  tendered  for  exchange,  and  thirty -year  three  per  centum 
gold  bonds  without  the  circulation  privilege  for  the  remainder  of  the 
two  per  centum  bonds  so  tendered:  Provided,  That  at  the  time  of 
such  exchange  the  Federal  reserve  bank  obtaining  such  one-year  gold 
notes  shall  enter  into  an  obligation  with  the  Secretary  of  the  Treas- 
ury binding  itself  to  purchase  from  the  United  States  for  gold  at  the 
maturity  of  such  one-year  notes,  an  amount  equal  to  those  delivered 
in  exchange  for  such  bonds,  if  so  requested  by  the  Secretary,  and  at 
each  maturity  of  one-year  notes  so  purchased  by  such  Federal  re- 
serve bank,  to  purchase  from  the  United  States  such  an  amount  of 
one-year  notes  as  the  Secretary  may  tender  to  such  bank,  not  to 
exceed  the  amount  issued  to  such  bank  in  the  first  instance,  in 
exchange  for  the  two  per  centum  United  States  gold  bonds;  said 
obligation  to  purchase  at  maturity  such  notes  shall  continue  in 
force  for  a  period  not  to  exceed  thirty  years. 

For  the  purpose  of  making  the  exchange  herein  provided  for,  the 
Secretary  of  the  Treasury  is  authorized  to  issue  at  par  Treasury 
notes  in  coupon  or  registered  form  as  he  may  prescribe  in  denomina- 
tions of  one  hundred  dollars,  or  any  multiple  thereof,  bearing 
interest  at  the  rate  of  three  per  centum  per  annum,  payable 
quarterly,  such  Treasury  notes  to  be  payable  not  more  than  one 
year  from  the  date  of  their  issue  in  gold  coin  of  the  present  standard 
value,  and  to  be  exempt  as  to  principal  and  interest  from  the  pay- 
ment of  all  taxes  and  duties  of  the  United  States  except  as  provided 
by  this  Act,  as  well  as  from  taxes  in  any  form  by  or  under  State, 
municipal,  or  local  authorities.  And  for  the  same  purpose,  the 
Secretary  is  authorized  and  empowered  to  issue  United  States  gold 
bonds  at  par,  bearing  three  per  centum  interest  payable  thirty  years 
from  date  of  issue,  such  bonds  to  be  of  the  same  general  tenor  and 
effect  and  to  be  issued  under  the  same  general  terms  and  conditions 
as  the  United  States  three  per  centum  bonds  without  the  circulation 
privilege  now  issued  and  outstanding. 

Upon  application  of  any  Federal  reserve  bank,  approved  by  the 
Federal  Reserve  Board,  the  Secretary  may  issue  at  par  such  three 
per  centum  bonds  in  exchange  for  the  one-year  gold  notes  herein 
provided  for. 

Bank  Reserves 

Sec.  19.  Demand  deposits  within  the  meaning  of  this  Act  shall 
comprise  all  deposits  payable  within  thirty  days,  and  time  deposits 
shall  comprise  all  deposits  payable  after  thirty  days,  and  all  savings 
accounts  and  certificates  of  deposit  wliich  are  subject  to  not  less  than 
thirty  days'  notice  before  payment. 


FEDERAL  RESERVE  ACT  401 

When  the  Secretary  of  tlie  Treasury  shall  have  olhcially  an- 
nounced, in  such  manner  as  he  may  elect,  the  establishment  of  a 
Federal  reserve  bank  in  any  district,  every  subscribing  member  bank 
shall  establish  and  maintain  reserves  as  follows: 

(a)  A  bank  not  in  a  reserve  or  central  reserve  city  as  now  or 
hereafter  defined  shall  iiold  and  maintain  reserves  equal  to  twelve  per 
centum  of  the  aggregate  amount  of  its  demand  deposits  and  live  per 
centum  of  its  time  deposits,  as  follows: 

In  its  vaults  for  a  period  of  thirty-six  months  after  said  date 
five-twelfths  thereof  and  permanently  tiiereafter  four-twelfths. 

In  the  Federal  reserve  bank  of  its  district,  for  a  period  of  twelve 
months  after  said  date,  two-twelfths,  and  for  each  succeeding  six 
months  an  additional  one-twelfth,  until  five-twelftl>s  have  been  so 
deposited,  which  shall  be  the  amount  permanently  required. 

For  a  period  of  tliirty-six  montlis  after  said  date  tiie  lialance  of 
the  reserves  may  be  held  in  its  own  vaults,  or  in  tiie  Federal  reserve 
bank,  or  in  national  banks  in  reserve  or  central  reserve  cities  as  now 
defined  by  law. 

After  said  thirty-six  months'  period  said  reserves,  other  than 
those  liereinbefore  required  to  be  held  in  tiie  vaults  of  tlie  member 
bank  and  in  tlie  Federal  reserve  bank,  siiall  be  held  in  tiie  vaults  of 
the  member  bank  or  in  the  Federal  reserve  bank,  or  in  both,  at  the 
option  of  tlie  member  bank. 

(b)  A  bank  in  a  reserve  city,  as  now  or  hereafter  defined,  shall 
hold  and  maintain  reserves  equal  to  fifteen  per  centam  of  the 
aggregate  amount  of  its  demand  deposits  and  five  per  centum  of  its 
time   deposits,   as  follows: 

In  its  vaults  for  a  period  of  thirty-six  months  after  said  date 
six-fifteenths    thereof,    and    permanently   thereafter    five-fifteenths. 

In  tiie  Federal  reserve  bank  of  its  district  for  a  period  of  twelve 
months  after  the  date  aforesaid  at  least  three-fifteenths,  and  for 
each  succeeding  six  months  an  additional  one-fiftoenth,  until  six- 
fifteenths  have  been  so  deposited,  which  shall  be  the  amount  per- 
manently  required. 

For  a  period  of  thirty-six  montlis  after  said  date  the  balance  of 
the  reserves  may  be  held  in  its  own  vaults,  or  in  the  Federal  reserve 
hank,  or  in  national  Iianks  in  [reserve  or  J*  central  reserve  cities  as 
now  defined  by  law. 

After  said  thirty-six  months'  period  all  of  said  reserves,  except 
those  liereinbefore  required  to  be  held  permanently  in  the  vaults  of 
the  member  bank  and  in  the  Federal  reserve  bank,  shall  be  held  in 
its  vaults  or  in  tlie  Federal  reserve  bank,  or  in  both,  at  the  option 
of  the  member  hank. 

(c)  A  bank  in  a  central  reserve  city,  as  now  or  hereafter  de- 
fined, shall  liold  and  maintain  a  reserve  equal  to  eighteen  jier 
centum  of  the  aggregat<'  amount  of  its  demand  deposits  and  five 
per   centum   of   its   time   deposits,   as   follows: 

In    its   vaults   six-oighteenths   thereof. 

In  the  Federal  reserve  bank  seven-eighteenths. 

The  balance  of  said  rc-^erves  shall  be  held  in  its  own  vaults  or  in 
the  Federal  reserve  hank,  at  its  option. 

Any  Federal  reserve  bank  may  receive  from  the  member  banks 
as    reserves,    not    exceeding    one  half    of    each    installment,    eligible 

*  The  above  words  in  brackets  were  stricken  mit  by  an  nmondnient 

np]irovod  August  ir>,  1014, 
«6 


402      OPERATION  OF  THE  NEW  BANK  ACT 

paper  as  descriljcd  iu  section  [fourteouj   ihirtcen,*  properly  ciidorscd 
and  accejjtable  to  the  said  reserve  baniv. 

If  a  State  bank  or  trust  company  is  required  by  the  law  of  its 
State  to  keep  its  reserves  either  in  its  own  vaults  or  witli  another 
State  bank  or  trust  company,  sucii  reserve  deposits  so  kept  in  sucli 
State  bank  or  trust  company  shall  be  construed,  within  the  meaning 
of  this  section,  as  if  they  were  reserve  deposits  in  a  national  bank  in 
a  reserve  or  central  reserve  city  for  a  period  of  tliree  years  after  tlie 
Secretary  of  the  Treasury  shall  have  officially  announced  the  estab- 
lishment of  a  Federal  reserve  bank  in  the  district  in  which  such 
State  bank  or  trust  company  is  situate.  Except  as  thus  provided, 
no  member  bank  shall  keep  on  deposit  with  any  nonmember  bank  a 
sum  in  excess  of  ten  per  centum  of  its  own  paid-up  capital  and 
surplus.  No  member  bank  shall  act  as  the  medium  or  agent  of  a 
nonmember  bank  in  applying  for  or  receiving  discounts  from  a 
Federal  reserve  bank  under  the  provisions  of  this  Act  except  by 
permission  of  the  Federal  Reserve  Board. 

The  reserve  carried  by  a  member  bank  with  a  Federal  reserve 
bank  may,  under  the  regulations  and  subject  to  such  penalties  as 
may  be  prescribed  by  the  Federal  Reserve  Board,  be  checked  against 
and  withdrawn  by  such  member  bank  for  the  purpose  of  meeting 
existing  liabilities:  Provided,  hoicever,  That  no  bank  shall  at  any 
time  make  new  loans  or  shall  pay  any  dividends  unless  and  until  the 
total  reserve  required  by   law   is   fully   restored. 

In  estimating  the  reserves  required  by  this  Act,  the  net  balance 
of  amounts  due  to  and  from  other  banks  shall  be  taken  as  the  basis 
for  ascertaining  the  deposits  against  which  reserves  shall  be  deter- 
mined. Balances  in  reserve  banks  due  to  member  banks  shall,  to 
the  extent  herein  provided,  be  counted  as  reserves. 

National  banks  located  in  Alaska  or  outside  the  continental 
United  States  may  remain  nonmember  banks,  and  shall  in  that  event 
maintain  reserves  and  comply  with  all  the  conditions  now  provided 
by  law  regulating  them;  or  said  banks,  except  in  the  Philippine 
Islands,  may,  with  the  consent  of  the  Reserve  Board,  become  member 
banks  of  any  one  of  the  reserve  districts,  and  shall,  in  that  event, 
take  stock,  maintain  reserves,  and  be  subject  to  all  the  other  pro- 
visions of  this  Act. 

Sec.  20.  So  much  of  sections  two  and  three  of  the  Act  of  June 
twentieth,  eighteen  hundred  and  seventy-four,  entitled  "  An  Act 
fixing  the  amount  of  United  States  notes,  providing  for  a  redistribu- 
tion of  the  national-bank  currency,  and  for  other  purposes,"  as  pro- 
vides that  the  fund  deposited  by  any  national  banking  association 
with  the  Treasurer  of  tlie  United  States  for  the  redemption  of  its 
notes  shall  be  counted  as  a  part  of  its  lawful  reserve  as  provided  in 
the  Act  aforesaid,  is  hereby  repealed.  And  from  and  after  the 
passage  of  this  Act  such  fund  of  five  per  centum  shall  in  no  case  be 
counted  by  any  national  banking  association  as  a  part  of  its  lawful 
reserve. 

Bank  Examinations 

Sec.  21.  Section  fifty-two  liundred  and  forty,  United  States  Re- 
vised Statutes,  is  amended  to  read  as  follows: 

The  Comptroller  of  the  Currency,  with  the  approval  of  the 
Secretary  of  the  Treasury,  shall  appoint  examiners  who  shall  ex- 

*  By  amendment  approved  August  15.  1914,  the  word  "  fourteen  " 
was,  in  eft'ect,  changed  to  read  "  thirteen." 


FEDERAL  RESERVE  ACT  40S 

amine  every  moniher  bank  at  least  twice  in  each  calendar  year  and 
oftener  if  considered  necessary:  Provided,  hoicever,  Tliat  tlie  Federal 
Reserve  Board  may  autiiorize  examination  by  the  State  authoritiea 
to  be  accepted  in  the  case  of  State  banks  and  trust  companies  and 
may  at  any  time  direct  the  holding  of  a  special  examination  of 
State  banks  or  trust  companies  tliat  are  stockholders  in  any  Federal 
reserve  bank.  The  examiner  makin^^  tlie  examination  of  any 
national  bank,  or  of  any  other  meml)er  i)ank,  shall  have  power  to 
make  a  thorough  examiiu\tion  of  all  the  affairs  of  the  bank  and  in 
doing  so  he  shall  have  power  to  administer  oaths  and  to  examine 
any  of  the  officers  and  agents  thereof  under  oath  and  shall  make  a 
full  and  detailed  report  of  the  condition  of  said  bank  to  the  Comp- 
troller of  the  Currency. 

The  Federal  Reser\e  Board,  upon  the  recommendation  of  the 
Comptroller  of  the  Currency,  shall  fix  the  salaries  of  all  bank  exam- 
iners and  make  report  thereof  to  Congress.  The  expense  of  the 
examinations  herein  provided  for  shall  be  assessed  by  the  Comp- 
troller of  the  Currency  upon  the  banks  examined  in  proportion  to 
assets  or  resources  held  by  the  banks  upon  the  dates  of  examination 
of  the  various  banks. 

In  addition  to  the  examinations  made  and  conducted  by  the 
Comptroller  of  the  Currency,  every  Federal  reserve  bank  may,  with 
the  approval  of  the  Federal  reserve  agent  or  the  Federal  Reserve 
Board,  provide  for  special  examination  of  member  banks  within  its 
district.  The  expense  of  such  examinations  shall  be  borne  by  the 
bank  examined.  Such  examinations  shall  be  so  conducted  as  to 
inform  the  Federal  reserve  bank  of  the  condition  of  its  member 
banks  and  of  the  lines  of  credit  which  are  being  extended  by  them. 
Kvery  Federal  reserve  bank  shall  at  all  times  furnish  to  tlie  Federal 
Reserve  Board  such  information  as  may  be  demanded  concerning  the 
condition  of  any  member  bank  within  the  district  of  the  said 
Federal  reserve  bank. 

No  bank  shall  be  subject  to  any  visitatorial  powers  other  than 
such  as  are  authorized  by  law,  or  vested  in  the  courts  of  justice  or 
such  as  shall  be  or  shall  have  been  exercised  or  directed  by  Con- 
gress, or  l)y  eiflior  House  tliercof  or  by  any  committet'  of  Congress 
or  of  either  House   duly  autliorized. 

The  Federal  Reserve  Board  shall,  at  least  once  each  year,  order 
an  examination  of  each  Federal  reserve  bank,  and  upon  joint  applica- 
tion of  ten  member  banks  Ihe  Federal  Reserve  Board  shall  order  a 
special  examination  and  report  of  the  condition  of  any  Federal 
reserve  bank. 

Sec.  22.  No  member  hank  or  any  ofhcer.  director,  or  employee 
tliereof  shall  hereafter  make  any  loan  or  grant  any  grnfuity  to  any 
bank  examiner.  Any  bank  ofTicer.  director,  or  employee  violat 
ing  this  provision  shall  be  deemed  guilty  of  a  misdetneanor  and  shall 
lie  imprisoned  not  exceeding  one  year  or  fined  not  more  than  .$.'>. 000. 
or  both  :  and  may  be  fined  a  furtlier  sum  ei^ual  to  tlie  money  so  loaned 
or  gratuity  given.  Any  examiner  accepting  a  loan  or  gratuity  from 
any  bank  examined  by  him  or  from  nn  officer,  director,  or  employee 
tliereof  shall  be  deemed  guilty  of  a  misdemeanor  and  shall  be  im- 
prisoned not  exceeding  one  year  or   fined   not  more  than   $.'>.000.  or 


401       OPERATION  OF  THE  NEW  BANK  ACT 

both;  and  may  be  fined  a  further  sum  equal  to  the  money  so  loaneu 
or  gratuity  given;  and  shall  forever  thereafter  be  disqualified  from 
holding  office  as  a  national-bank  examiner.  No  national-bank  ex- 
aminer sliall  perform  any  other  service  for  compensation  while  hold- 
ing such  odice  for  any  bank  or  officer,  director,  or  employee  thereof. 

Other  than  the  usual  salary  or  director's  fee  paid  to  any  officer, 
director,  or  employee  of  a  member  bank  and  other  tlian  a  reasonable 
fee  paid  by  said  bank  to  such  officer,  director,  or  employee  for  ser- 
vices rendered  to  such  bank,  no  officer,  director,  employee,  or 
attorney  of  a  member  bank  shall  be  a  beneficiary  of  or  receive, 
directly  or  indirectly,  any  fee,  commission,  gift,  or  other  considera- 
tion for  or  in  connection  with  any  transaction  or  business  of  the 
bank.  Ko  examiner,  public  or  private,  shall  disclose  the  names  of 
borrowers  or  the  collateral  for  loans  of  a  member  bank  to  other  than 
the  proper  officers  of  such  bank  without  first  having  obtained  the 
express  permission  in  writing  from  the  Comptroller  of  the  Currency, 
or  from  the  board  of  directors  of  such  bank,  except  when  ordered  to 
do  so  by  a  court  of  competent  jurisdiction,  or  by  direction  of  the 
Congress  of  the  United  States,  or  of  either  House  thereof,  or  any 
committee  of  Congress  or  of  either  House  duly  authorized.  Any 
person  violating  any  provision  of  this  section  shall  be  punished  by 
a  fine  of  not  exceeding  $5,000  or  by  imprisonment  not  exceeding 
one  year,  or  both. 

Except  as  provided  in  existing  laws,  this  provision  shall  not  take 
eflfect  until  sixty  days  after  the  passage  of  this  Act. 

Sec.  23.  The  stockholders  of  every  national  banking  association 
shall  be  held  individually  responsible  for  all  contracts,  debts,  and 
engagements  of  such  association,  each  to  the  amount  of  his  stock 
therein,  at  the  par  value  thereof  in  addition  to  the  amount  invested 
in  such  stock.  The  stockholders  in  any  national  banking  association 
who  shall  have  transferred  their  shares  or  registered  the  transfer 
thereof  within  sixty  days  next  before  the  date  of  the  failure  of  such 
association  to  meet  its  obligations,  or  with  knowledge  of  such  im- 
pending failure,  shall  be  liable  to  the  same  extent  as  if  they  had 
made  no  such  transfer,  to  the  extent  that  the  subsequent  transferee 
fails  to  meet  such  liability:  but  this  provision  shall  not  be  con- 
strued to  alTect  in  any  way  any  recourse  which  such  shareholders 
might  otherwise  have  against  those  in  whose  names  such  shares  are 
registered  at  the  time  of  such  failure. 

Loans  on  Fabm  Lands 

Sec.  24.  Any  national  banking  association  not  situated  in  a 
central  reserve  city  may  make  loans  secured  by  improved  and  unen- 
cumbered farm  land,  situated  within  its  Federal  reserve  district,  but 
no  such  loan  shall  be  made  for  a  longer  time  than  five  years,  nor 
for  an  amount  exceeding  fifty  per  centum  of  the  actual  value  of  the 
property  offered  as  security.'  Any  such  bank  may  make  such  loans 
in  an  aggregate  sum  equal  to  twenty-five  per  centum  of  its  capital 
and  surplus  or  to  one-third  of  its  time  deposits  and  such  banks  may 
continue  hereafter  as  heretofore  to  receive  time  deposits  and  to  pay 
interest  on  the  same. 


FEDERAL  RESERVE  ACT  405 

The  Federal  Reserve  Board  shall  have  power  from  time  to  time 
to  add  to  the  list  of  cities  in  which  national  banks  shall  not  be 
permitted  to  make  loans  secured  upon  real  estate  in  the  manner 
described  in  this  section. 

Foreign  Branches 

Sec.  25.  Any  national  banking  association  possessing  a  capital 
and  surplus  of  $1,000,000  or  more  may  file  application  with  the 
Federal  Reserve  Board,  upon  such  conditions  and  under  such  regula- 
tions as  may  be  prescribed  by  tlie  said  board,  for  the  purpose  of 
securing  authority  to  establish  branches  in  foreign  countries  or 
dependencies  of  tlie  United  Stiites  for  tlie  furtlierance  of  the  foreign 
commerce  of  the  United  States,  and  to  act,  if  required  to  do  so,  as 
fiscal  agents  of  the  United  States.  Such  application  shall  specify, 
in  addition  to  tlie  name  and  capital  of  tlie  banking  association  filing 
it,  the  place  or  places  where  the  banking  operations  proposed  are  to 
be  carried  on,  and  the  amount  of  capital  set  aside  for  the  conduct  of 
its  foreign  business.  The  Federal  Reserve  Board  shall  have  power 
to  approve  or  to  reject  such  application  if,  in  its  judgment,  the 
amount  of  capital  proposed  to  be  set  aside  for  the  conduct  of  foreign 
business  is  inadequate,  or  if  for  other  reasons  the  granting  of  sucli 
application  is  deemed  inexpedient. 

Every  national  banking  association  which  shall  receive  authority 
to  establish  foreign  branches  shall  be  required  at  all  times  to  furnish 
information  concerning  the  condition  of  sucli  branches  to  tlie  Comp- 
troller of  the  Currency  ui)on  demand,  and  the  Federal  Reserve  Board 
may  order  special  examinations  of  the  said  foreign  branches  at  such 
time  or  times  as  it  may  deem  best.  p]very  such  national  banking 
association  shall  conduct  the  accounts  of  each  foreign  branch  inde- 
pendently of  the  accounts  of  other  foreign  branches  established 
by  it  and  of  its  home  office,  and  shall  at  the  end  of  each  fiscal  period 
transfer  to  its  general  ledger  the  profit  or  loss  accruing  at  each 
branch  as  a   separate  item. 

Sec.  2C.  All  provisions  of  law  inconsistent  with  or  superseded 
by  any  of  the  provisions  of  this  Act  are  to  that  extent  and  to  that 
extent  only  hereby  repealed:  Provided,  Nothing  in  this  Act  con- 
tained shall  be  construed  to  repeal  the  parity  provision  or  provisions 
contained  in  an  Act  approved  March  fourteenth,  nineteen  hundred, 
entitled  "  An  Act  to  define  and  fix  the  standard  of  value,  to  main- 
tain the  parity  of  all  forms  of  money  issued  or  coined  by  the  United 
States,  to  refund  the  public  debt,  and  for  other  purposes,"  and  the 
Secretary  of  the  Treasury  may  for  the  purpose  of  maintaining  such 
parity  and  to  strengthen  the  gold  reserve,  borrow  gold  on  the 
security  of  United  States  bonds  authorized  by  section  two  of  the 
Act  last  referred  to  or  for  one-year  gold  notes  bearing  interest  at  a 
rate  of  not  to  exceed  three  per  ceiitiun  per  annum,  or  sell  the  same 
if  necessary  to  obtain  gold.  Wiien  the  funds  of  the  Treasury  on 
hand  justify,  he  may  purchase  and  retire  such  outstanding  bonds 
and  notes. 

Sec.  27.  The  provisions  of  the  Act  of  May  tiiirtieth,  nineteen 
hundred  and  eight,   authorizing  national   currency   associations,   the 


406       OPERATION  OF  THE  NEW  BANK  ACT 

issue  of  additional  national-bank  circulation,  and  creating  a  National 
Monetary  Commission,  which  expires  by  limitation  under  the  terms 
of  such  Act  on  the  thirtieth  day  of  June,  nineteen  hundred  and  four- 
teen, are  hereby  extended  to  June  thirtieth,  nineteen  hundred  and 
fifteen,  and  sections  fifty-one  hundred  and  fifty-three,  fifty-one 
hundred  and  seventy-two,  fifty-one  hundred  and  ninety-one,  and 
fifty-two  hundred  and  fourteen  of  the  Revised  Statutes  of  the  United 
States,  which  were  amended  by  the  Act  of  May  thirtietli,  nineteen 
hundred  and  eight,  are  hereby  reenacted  to  read  as  such  sections 
read  prior  to  May  thirtieth,  nineteen  hundred  and  eiglit,  subject  to 
such  amendments  or  modifications  as  are  prescribed  in  this  Act: 
Provided,  however,  That  section  nine  of  the  Act  first  referred  to  in 
this  section  is  hereby  amended  so  as  to  change  the  tax  rates  fixed 
in  said  Act  by  making  the  portion  applicable  thereto  read  as 
follows : 

National  banking  associations  having  circulating  notes  secured 
otherwise  than  by  bonds  of  the  United  States,  shall  pay  for  the  first 
three  months  a  tax  at  the  rate  of  three  per  centum  per  annum  upon 
the  average  amount  of  such  of  their  notes  in  circulation  as  are  based 
upon  the  deposit  of  such  securities,  and  afterwards  an  additional  tax 
rate  of  one-half  of  one  per  centum  per  annum  for  each  month  until  a 
tax  of  six  per  centum  per  annum  is  reached,  and  thereafter  such  tax 
of  six  per  centum  per  annum  upon  the  average  amount  of  such 
notes. 

Sec.  28.  Section  fifty-one  hundred  and  forty-three  of  the  Ee- 
vised  Statutes  is  hereby  amended  and  reenacted  to  read  as  follows: 
Any  association  formed  under  this  title  may,  by  the  vote  of  share- 
holders owning  two-thirds  of  its  capital  stock,  reduce  its  capital  to 
any  sum  not  below  the  amount  required  by  this  title  to  autliorize 
the  formation  of  associations;  but  no  such  reduction  shall  be  allow- 
able which  will  reduce  the  capital  of  the  association  below  the 
amount  required  for  its  outstanding  circulation,  nor  shall  any  reduc- 
tion be  made  until  the  amount  of  the  proposed  reduction  has  been 
reported  to  the  Comptroller  of  the  Currency  and  such  reduction  has 
been  approved  by  the  said  Comptroller  of  the  Currency  and  by  the 
Federal  Reserve  Board,  or  by  the  organization  committee  pending 
the   organization  of  the   Federal  Reserve   Board. 

Sec.  29.  If  any  clause,  sentence,  paragraph,  or  part  of  this  Act 
shall  for  any  reason  be  adjudged  by  any  court  of  competent  juris- 
diction to  be  invalid,  such  judgment  shall  not  afi'ect,  impair,  or 
invalidate  the  remainder  of  this  Act,  but  shall  be  confined  in  its 
operation  to  the  clause,  sentence,  paragraph,  or  part  thereof  directly 
involved  in  the  controversy  in  which  such  judgment  shall  have  been 
rendered. 

Sec.  30.  The  right  to  amend,  alter,  or  repeal  this  Act  is  hereby 
expressly  reserved. 

Approved,  December  23,  1913. 


13 

5 

14 

1 

1.} 

3-4 

14 

1 

13 

3 

INDEX  TO  FEDERAL  RESERVE  ACT 

AldkiCH-Vkeeland    xVct:                                           I'age  Section  I'uragraph 

Extended  to  June  30,  1915 400  27  1 

Provisions  of  original  Act  restored 400  27  1 

Tax  rate  on  emergency  issues  altered. .  .   40G  27  2 

I3ank  Acceptances: 

Autiiorized 394 

Eligible  for  open  market  operations.  .  .  .    394 

Limitations  u|)on  rediscounts  of 394 

May    be    purchased    or    sold    by    reserve 
banks ! 394 

What  may  be  discounted 394 

Bank: 

Definition  of   379  1  2 

I5A.NK  Examiners    (See  Examiners) 
1?AXK  Examinations    (See  Examinations) 
Bank  Reserves   (See  Reserve) 
Bills  of  Exchange: 

Eligible  for  open  market  operations.  .  .  .    394  14  1 

Eligible    for    rediscount 394         13  4 

Bonds,  United  States: 

Charter  bonds  no  longer  required 398         17  1 

]May  be  retired  by  Secretary  of  the  Treas- 
ury       40.> 

May  be  sold  by  him 40;") 

Turchases  of,  by  reserve  banks 399 

Refunding  two  per  cent  issues 399 

Surplus  earnings  of  reserve  banks  may  be 

used  to  retire   ." ...   387  7  2 

Branches  of  National  Banks: 

Autliori/.ed  and  described   405         25  1-2 

Branches  of  Resernt  Banks: 

How  established   382 

TTow    selected    382 

Afanaged  by  Board  of  Directors 382 

Manager  of   382 

Cable  Transfers: 

Eligible  for  open  market  operations.  .  .  .    394  14  1 

May   be   purchased   and  sold   bv   reserve 

banks    .' 394  14  1 

Capital  Requirements  of  National  Banks 

Reduction  of  capital   provided  for 400         28  1 

Central  Reserve  Cities: 

Present  classification  continued   381  2  13 

Reserves  required  in 401  19  13 

407 


20 

1 

20 

1 

IS 

2-4 

18 

1-9 

3 
3 

1 

1 

3 

3 

1 
1 

ctiou 

I'aragraph 

16 

14 

16 

14 

13 

2 

16 

13,  14 

16 

13,  14 

16 

2 

13 

2 

408  INDEX,  FEDERAL  RESERVE  ACT 

Clearing  Checks  and  Dkaits  ( See  Clearing 

House  and  Collection  Ciiarges)  rage 

Clearing  House: 

Federal  Reserve  Board  as   3'J& 

Reserve  banks 398 

Collateral  Loans: 

Not  eligible  for  rediscount 393 

Collection  Charges: 

By  member  banks .   398 

By  reserve  banks   398 

Commercial  Paper: 

As  security  for  reserve  notes   396 

What  eligible  for  rediscount    393 

Comptroller  of  the  Currency: 

Control  over  bank  examinations  and  ex- 
penses  thereof    402         21  1-6 

Control  over  foreign  branches  of  national 

banks    405         25  1 

Control  over  preparation  of  notes 398         16  10 

Member   of   organization   committee....    379  2  1 

Must    approve    reduction    of   capital    of 

national  banks   406         28  1 

^York  in  organizing  reserve  banks 382  4  1 

Congress  : 

Power  to  examine  banks  reserved 403         21  5 

Conversion  of  State  Banks  into  National 

Banks   (See  State  Banks) 
Country  Banks: 

Reserve  requirements    401         19  3-7 

Court  Decisions: 

Effect  of  on  Act  prescribed 406         29  1 

Currency   Act  of   March    14,    1900: 

Reaffirmed   405         26  1 

Deposits  : 

Balances  with  other  banks   402 

By  members  with  nonmembers  limited.  .   402 

Demand  defined   ' 400 

Forms  acceptable  at  reserve  banks....   398 

Reserves  against  (member  banks) 401 

Reserves  against   (reserve  banks) 396 

Deputy    Chairman    and    Deputy    Federal 
Reserve    Agents : 

Duties  of   385 

How   chosen    385 

Qualifications  of    385 

Directors : 

Of  branch  banks    (see  Branch  Banks)  . 

Of  Federal  reserve  banks    (see  Federal 
Reserve  Banks) 


19 

17 

19 

15 

19 

1 

16 

13 

19 

3-13 

16 

3 

4 

30 

4 

30 

4 

30 

INDEX,  FEDERAL  RESERVE  ACT  409 

DiREOTORS — Continued  Page    Section    Paragraph 

Of  member  banks,  fees  or  commissions 

for  loans  prohibited,  penalty  for 403         22  1-2 

Dissolution  OF  Memher  Banks,  Effect.  .. .   380  2  6-7 

District    (See  also   Districting  tlie   United 
States) : 

Definition  of   37!f  1  3 

To  be  designated  by  number 379  2  1 

District    Reserve    Elector     (See    Federal 

Reserve  Bank) 
Districting  the  United  States: 

How  to  be  done   37!)  2  1 

May  be  readjusted  379  2  1 

Not  necessarily  coterminous  with  state 

lines    379  2  1 

To  be  designated  by  number 379  2  1 

To  be  done  by  organization  committee.  .    379  2  1 

Division  of  Earnings    (See   Earnings) 

Earnings  (See  Federal  Reserve  Banks) 
Eligibility  to  Membership    (See  National 

Banks  and  State  Banks) 
Emergency    Currency     (See    Aldricli-Vree- 

land   Act) 
Examinations: 

Expenses  of,  how  paid   403 

Of  member  banks    403 

Other  visitatorial  powers    403 

Periodical    403 

Special  examinations  bj'  order  of  Federal 

Reserve   Board    \ 403         21  2,6 

Examiners: 

Fees  and  gratuities  forbidden 403         22  1 

How   appointed    403         21  2 

Not  to  perform  other  services  for  banks 

examined    404         22  1 

Not    to    receive    gratuities    from    banks 

examined    403 

Penalty  for 403 

Salaries  fixed  by  Reserve  Board 403 

Salaries  paid  by  banks  examined 403 

Farm  Lands  (See  Loans  on  Farm  Lands) 
Federal  Advisory  Council: 

How  appointed   392 

Meetings    393 

Powers    393 

Quorum    393 

Federal  Reserve  Agent: 

As  trustee  for  collateral  again.st  reserve 

notes   397  1 0  5-7 


21 

3 

21 

2,4,5 

21 

5 

21 

2 

22 

1 

22 

1 

21 

3 

21 

3 

12 

1 

12 

1 

12 

2 

12 

1 

410  INDEX,  FEDERAL  RESERVE  ACT 

Federax  Reserve  Agent — Continued  rage    Section    I'aragraph 

How  cliosen   385  4  30 

Qualifications   of    385  4  30 

Reserve  notes  issued  through 395  16  1-2 

Salary,  how  determined  and  paid 385  4  30 

Federal  Reserve  Banks: 

As  clearing  houses    398  16  14 

Branches   (see  Branch  Banks) 382  3  1 

Balloting  for  directors  of,  how  done.  .  .  .   384  4               27-29 

Chartered  for  twenty  years 383  4  6 

Decrease  and  increase  of  stock 386  5  1 

Deposits  with   393  13  1 

Directors,  how  elected    383  4               17-33 

Class  A,  by  member  banks 384  4  18 

Class  B,  by  member  banks 384  4  19 

Class  C,  by  Federal  Reserve  Board  384  4  20 

Class  C,  directors,  qualifications  of  385  4  30 

Directors,  salaries  and  expenses  of  ....   385  4  31 

Earnings    387  7  2 

Electors,  how  selected 384  4  26 

Fiscal  agent  of  government,  may  act  as  395  15  1 
Forbidden  to  pay  out  reserve  notes  issued 

by  other  banks   396  10  3 

Government  deposits  with,  authorized.  .   395  15  1 

Government  disbursements  from   395  15  1 

How  organized   382  4  1 

Liability  of  shareholders  of   380  2  4 

Limitations  of  purchase  of  United  States 

bonds    399  IS  2 

IMay  be  government  depositaries  and  re- 
quired to  act  as  fiscal  agents 393  13  1 

May  exchange  2  per  cent  bonds  pvirchased 

for  3  per  cent  bonds    400  18  7-8 

May  issue  notes  against  bonds  purchased  383  4  12 

399  18  5-7 

Minimum  capitalization  of   381  2  13 

Must    be    administered    fairly    and    im- 
partially        383  4  16 

Must  maintain  redemption  fund    397  16  4 

Must  re-purchase  one-year  bonds   from 

year  to  year   400  18  7 

Name  of  . '. 380  2  2 

National  banks  to   signify   intention   to 

become   members    380  2  3 

No  senator  or  congressman  eligible  for 

board  of  directors  of 384  4  21 

Organization  certificate  of    382  4  2, 3 

Organized  bv  Reserve  Bank  Organization 

Committe'e    ^ 379  2  2 

Payments,  how  made 380  2  3 


Sc'fliou 

raiagrapli 

14 

2 

4 

4-12 

14 

2-7 

4 

lU, 

11,  14,  15 

4 

13,  1    12 

4 

28 

18 

2 

4 

3:{ 

3 

1 

INDEX,  FEDERAL  RESERVE  ACT  411 

Federal  Kesebve  Banks — Continued  I'age 

Powers  of,  concerning  open-market  oper- 
ations     394 

Powers  of,  defined  383 

394 

Powers  of  reserve  banks 383 

393 

Preferential   ballot    384 

Kequired  to  purcliase  'J.  per  cent  govern- 
ment bonds  at  par  after  two  years..   399 

Rotation  of  directors  of,  iiow  arranged.    385 

ISliall  establish  brandies 382 

Stock    (see  Stock) 

Subscription  of  member  banks  0  per  cent 

of  capital  and  surplus 380  2  3 

Taxation,  to   be  free  of  except  on   real 

estate    387  7  3 

To  receive  checks  at  par 398         IG  13 

Federal  Re.5erve  Hoard: 

Annual   report  required    391  10  7 

Control  over  foreign  branches  of  national 

banks    405         25  1,2 

Control  over  issue  of  Federal  reserve 
notes    395 

Definition  of   379 

Discount  rate,  power  to  review 395 

Expenses,  how   paid    390 

First  meeting   390 

Foreign  operations  of  reserve  banks 
under  control  of  395 

General  enumeration  of  powers  of 391 

General  supervision  of  examinations.  .  .  .    402 

Governor  and   vice-governor    390 

How  appointed   389 

May  act  as  clearing   house   for   Federal 

reserve  banks    398         16  14 

May  admit  national  banks  in  Alaska  or 
outside  continental  United  States....    402 

May  fix  salaries  of  examiners 403 

Mav  require  meml)ers  to  surrender  mem- 
bership        389 

!^fay  restore  membership   389 

May  review  salaries  of  directors,  of  ofii- 

cers  and  emj)loyees  of  reserve  banks.    385  4  31 

Members  ineligil)lc  to  serve  as  directors 
or  officers  of  member  banks  for  two 
years  after  retirement 300 

Membership  of    389 

Must  apjirove  rediiction  of  capital  of 
national  banks   400 

Oath  of  ofrice  of   390 


IG 

1-14 

1 

3 

14 

6 

10 

3 

10 

4 

14 

4 

11 

1-12 

21 

1-0 

10 

2 

10 

1,2 

19 

18 

21 

3 

9 

5 

9 

6 

in 

2 

10 

1 

28 

1 

10 

2 

412  INDEX,  FEDERAL  RESERVE  ACT 

Feuerai.  liESEBVE  BoARD — Continued  Page 

Officers  of    390 

Powers  not  to  conllict  with  those  of  the 

Secretary  of  the  Treasury 390 

Power  to  fix  rules  governing  exchange 

charges  398 

Power  to  limit  loans  on  farm  land 405 

Purchase  of  United  States  bonds,  munici- 
pal  warrants,   etc.,   by   reserve   banks 

under  control  of    395 

Qualifications  of  members   390 

Right   to   define    paper   eligible   for    re- 
discount       393 

Salaries    389 

Secretary  of  the  Treasury,  Comptroller 

of  the  Currency,  members  ex-officio..    389         10 
Secretary     of     the     Treasury     ex-officio 

chairman    390         10 

Shall    formulate    rules    governing    open 

market  operations   394         14 

Shall    prescribe    regulations    governing 

State  bank  membership   388 

Shall  regulate  rediscounl^ 394 

Terms  of  office   390 

To  supervise  issue  of  currency  secured  by 

United   States  bonds    .  . . '. 391 

Vacancies,  how  filled 390 

Federal  Reserve  Districts: 

Definition  of   379 

Designation  by  number   379 

How  changed   379 

Number    379 

Revision  by  Reserve  Board   379 

Federal  Reserve  Notes: 

Gleneral   provisions    395 

Fiscal  Agents  of  United  States: 

Foreign  branches  of  national  banks.  .  .  .   405 

Reserve   banks    395 

Foreign  Acceptances    (See  Bank  Acceptances) 
Foreign  Branches  (See  National  Banks  and 

Reserve  Banks) 
Franchise  Tax: 

Surplus  earnings  of  reserve  banks  above 
dividends  to  be  paid  as 387 

Gold: 

Reserve  to  be  maintained  by  Secretary 

of  Treasury  .' \   396 

405 
Used  in  redeeming  Federal  reserve  notes  396 


Section 

raragraph 

10 

2 

10 

6 

16 

14 

24 

2 

14 

4 

10 

4 

13 

2 

10 

1 

9 

2 

13 

12 

10 

2 

10 

8 

10 

4-5 

2 

1 

2 

1 

2 

1 

2 

1 

2 

1 

16 

1-14 

25 

1 

15 

1 

16 

3 

26 

1 

16 

3 

INDEX,  FEDERAL  RESERVE  ACT  413 

Gold   Reserve:  Page    Section    I'aragrapb 

Portion  of  earnings  of  reserve  banks  may 

be  used  to  create 3S7  7  2 

Gold  Standard  Act   (See  Currency  Act  of 

March  14,  1900) 
Government  Deposits: 

May  be  made  with  Federal  reserve  banks  395         15  1 

May  be  made  with  member  banks 395         15  2 

Inconsistent  Laws  Repealed 405        26  1 

Interest: 

On  Federal  reserve  notes  397         IG  4 

Loans  on  Farm  Lands: 

Amount  and  length  of  such  loans 404         24  2 

Federal  Reserve  Board  may  curtail  list.   405         24  2 

National  banks  not  in  reserve  cities  may 

make     *.   404         24  1 

Membeb  Banes: 

Definition  of   379  1  3 

Membership: 

Banks  in  Alaska 402         19  18 

Banks  outside  continental  United  States  402         19  18 

Mortgages  (See  Loans  on  Farm  Lands) 

Municipal  Securities  (See  Federal  Reserve 
Banks) 

National  Banks: 

Definition    379  1  3 

Directors  of,  liable  for  losses  from  non- 
compliance        380  2  6 

Dissolution  of,  does  not  impair  remedy  of 

others   against    381  2  7 

Failing  to  accept  Act  within  sixty  days 
liable  to  loss  of  privilege  of  reserve 
agent    380  2  5 

Failing   to   become  member   within  one 

year  dissolved .   380  2  5 

Indebtedness  of,  limited  394         13  6-11 

Limitation  of  liabilities  extended  to  in- 
clude debts  due  under  Federal  Reserve 
Act    394         in  11 

May  establish  foreign  branches 405         25  1-2 

Must   accept    provisions   of   Act    within 

sixty  days   380  2  5 

Must  subscribe  to  stock  of  reserve  bank, 

conditions  of 380  2  3 

Need  not  deposit  U.  S.  Government  bonds 

before  commencing  business    399         17  1 

Noncompliance  with  Act  subject  to  ju- 
dicial review   380  2  6 


414  INDEX,  FEDERAL  RESERVE  ACT 

National  Banks — Continued  Page    Section    Taragraph 

Payments  for  reserve  bank  stock  by .  .  .   .'i80  2  3 

Reduction  of  capital  stock,  how  effected  4UG         28  1 

Reserve  Board  may  require  surrender  of 

membership      389  9  5 

Resolution    makin<j    application    for    re- 
serve bank  membership    382  4  1 

National  Bank  Notes: 

Retirement  made  possible 399         18  1-9 

"  Net  Deposits"  : 

Reserves  figured  against   402         19  17 

Nonmember   Banks : 

Can  not  hold  Government  deposits 395         15  2 

Limitation  on  rediscounts  by  members 

for     402         19  15 

Note  Issue    (See  Federal  Reserve  Notes) 

One-year  Gold  Notes: 

May  be  sold  by  Secretary  of  Treasury .  .   405         26  1 

May  retire  same 405        26  1 

Open  Market  Operations: 

Authorized  and  defined 394         14  1 

Organization  Committee  ( See  Reserve  Bank 
Organization  Committee) 

Powers   of  Federal   Reserve   Board    (See 

Federal   Reserve   Board) 
Public  Stock   (See  Federal  Reserve  Banks) 
Public  Subscriptions  (See  Federal  Reserve 

Banks ) 

Real  Estate  Loans    (See  Loans   on   Farm 
Lands ) 

Redemption  Fund: 

No  longer  a  part  of  reserves 402         20  1 

Rediscounting  : 

By  nonmember  through  member 402         19  15 

Conditions  governing    393         13  2 

Paper  eligible  for    393         13  2 

Paper  used  as  collateral  for  reserve  notes  396         16  2 

Repeal  of  Conflicting  Legislation 405        26  1 

Reserve  Bank  (See  Federal  Reserve  Bank) 

Reserve  Bank  Notes   (See  Federal  Reserve 
Notes ) 

Reseb\'e    Bank    Organization    Committee 
(See  also  Federal  Reserve  Board) 
Actions  subject  to  review  only  by  Reserve 

Board   379  2  1 

Appropriation  for    381  2  13 

Can  summon  Avitnesses  and  investigate.    379  2  2 

Composition  of   379  2"  1 


INDEX.  FEDERAL  RESERVE  ACT  415 

I'uge  Section     I'nragrapb 
IvKSEKVE   Bank  Okgamzatiu.n   CoMiUXTEE — Continued 

Duties  of   379  2  1 

Majority  shall  constitute  a  quorum....   379  2  1 
Alay  employ  counsel,  experts  and  assist- 
ants         379  2  1 

381  2  13 

May  organize  the  reserve  banks 385  4  3J 

May  prescribe  regulations  governing  ad- 
mission of  State  banks 388  9  2 

Must    approve    reduction    of    capital    of 

national  banks   400  28  1 

Powers  of    379  2  2 

Shall  supervise  organization  of  reserve 

banks    380  2  2-3 

Reserve  City  Banks: 

Present  classification  continued 381  2  13 

Reserves   required    401  19  8-12 

Reserve   Requirements  : 

Against  Federal  reserve  notes 39G  10  3 

Balances  with  other  banks 402  19  17 

Central  reserve  cities    401  19  13 

Checking  against  reserves   authorized..   402  19  10 

Country  banks    401  19  3-7 

Ceneral    provisions    400  19  1-lS 

Of  reserve  banks  against  deposits 390  10  3 

Redemption  fund  excluded   402  20  1 

Rediscounting  to  create   401  19  14 

Reserve  cities   401  19  S-12 

State  bank  reserves   402  19  15 

Restrictions  Imposed  upon  Member  State 

Banks    (See   State   Banks) 

Retirement  of  National  Bank  Notes....   399  IS  1-8 

Savings  Deposits   (See  Time  Deposits) 

Secretary  of  the  Treasury: 

Control  over  Covernment  deposits 395  15  1-2 

May  borrow  to  strengthen  gold  reserve.   405  20  1 

]\Iay  issue  three  per  cent  bonds 400  18  8-9 

Member  of  organization  committee 379  2  1 

State  Banks: 

Conditions    of    jnembership    to    ho    pre- 
scribed        388  9  2 

Definit  ion  of   379  1  2 

How  converted  to  national  banks 387  8  1-3 

May  become  mend)ers  as 388  9  1 

Must    have     naid-up     capital     equal     to 

national  banks    388  9  2 

Penalty  for  violation  of  provisions 389  9  4 

Regulations     whicli     must    be    accepted 

when  members    389  9  3 


416  INDEX,  FEDERAL  RESERVE  ACT 

State  Banks — Continued  I'age    Section    I'aragraph 

Reserve  Board  can  require  surrender  of 

membership    389  9  5 

Reserve  required  of  402         19  15 

Subject  to  certain  sections  of  National 

Bank   Act    389  9  4 

Stock : 

Amount  to  be  subscribed  and  paid  in  by 

member  banks    386  5  1 

Certificates  concerning  increase  and  de- 
crease of    386  5  1 

386  G  1 

How    public    and    United    States    stock 

transferred    381  2  9 

Increased  and  decreased  with  capital  and 

surplus  of  members 386  5  1 

Insolvent  member  bank,  disposal  of  stock 

of     386  6  1 

Maximum  holding  of,  limited  to  $25,000  381  2  9 

Member  banks,  subscription  by 380  2  3 

Minimum  capital  for  anv  Federal  reserve 

bank    " 381  2  13 

Non-voting,  what  stock  so  classed 381  2  11 

Par  value  of  386  5  1 

Public  stock,  conditions  of  offering  of..   381  2'  3 

definition   of    381  2  9 

Reserve  Board  to  formulate  rules  gov- 
erning transfer  of   381  2  12 

Surrendered  stock,  how  paid  for   386  5  1 

United  States  stock,  conditions  of  crea- 
tion of    381  2  10 

how  disposed  of  381  2  10 

how  paid  for    381  2  10 

Voluntary   liquidation   of  member   bank 

requires  surrender  of 386  5  1 

Stockholders  of  Natioxal  Baxk.s: 

Double  liability  modified  and  defined..  .   404         23  1 

Surplus  for  Reser\t;  Banks  to  be  Created  387  7  1 

Suspending  Reserve  REQLTiREsrENTS : 

Reserve  Board  may  suspend  391         11  3 

Taxation,  Changes  in: 

Emergencv    issues    under    Aldrich-Vree- 

land   Act    406         27  2 

Time  Deposits: 

Definition  of   400         19  1 

Reserve   on    401  19  3. 8.  13 

Trust  CoirPANT   (See  State  Banks): 

Definition  of   379  1  3 

United   States   Treasury  : 

Federal  reserve  notes  redeemed  at 396         16  3 


GENERAL  INDEX 


(For  separate  index  of  tlie  Federal  Reserve  Act  see  page  407.) 

Administrative  clianges  in  banking  legislation,  349 

Advantages:   of  national  banks,  3G8;  of  open  market  operations,  171  ; 

to  country  lianks,  34'J 
Agricultural  credit  banks,  establisliment  of,  342 
Aid  in  distress,  0;  clearing  houses,  7;  emergencv  nietliods,  7 
Aldrich-Vrecland  Act  of  May  30,  1!»08,  18;  extended  to  June  30,  1915, 

24;    National   Monetary   Comniission   appointed,    I'J;    objections 

to,  18;   provisions  altered,  24;   rediscounting,  114 
American  Bankers'  Association  at  Boston,  resolutions  of  "  Country 

Banks,"  232 
American  trade,  extension  of,  177 
Analysis  of  withdrawals  and  balances  which  reserve  banks  have  on 

deposit  witli  central  reserve  agents,  270 
Assumptions  concerning  extent  of  witlidrawals  from  central  reserve 

city  banks,  298-303 

Balance  of  power  between  large  and  small  banks,  55 

Balances  of  reserve  banks,  217 

Balances  with  reserve  agents,  effect  on,  270 

Balances  witii  reserve  banks,  rediscounting  to  create,  308 

Bank  acceptances:  limitations,  124;  open  market  operations,  174; 
procedure  abroad,  115 

Bank  examinations:  changes  in,  24;  modiflcation  of  system  of  fees, 
351  ;  new  provisions  concerning,  350 

liank  examiners,  salaries  of,  91 

Banking  and  currency  laws,  clianges  in,  18 

Banking  methoils  and  business,  changes  in,  32 

Bank  of  England:  aided  by  Bank  of  France,  07;  aided  by  Russian 
Imperial  Bank,  (i7  ;  brandies  of,  57;  capital  and  surplus  of,  60; 
consols  sold,  180;  elasticity  of  note  issues,  143;  limited  selections 
for  directorates,  73;  not  required  to  maintain  reserve  against 
deposits,  145;  note  issues,  140;  panic  of  1907,  07;  reserves  kept 
by,    148;    reserve   policy   of,   2S7 

Bank  of  France:  aids  liank  of  England  in  Baring  Bros,  failure,  07 
aids    Bank   of   England    in    United    States   panic   of    1907,   67 
brandies  of,  57;  limit  on  note  issues,  102;  not  re<inired  to  main 
tain   reserve   against   deposits,    145;    note    issues,    140;    reserves 
kept  by,  148;   reserve  policy  of,  288;  restrictions  as  to  member- 
ship on  Board  of  Directors,  73 

Bank  of  Germany:  excess  issues  taxes,  102;  not  required  to  maintain 
reserve  against  deposits,  145;  note  issues,  140;  reserves  kept  bv, 
148;   reserve  policy  of,  288 

27  417 


418  GENERAL  INDEX 

Bank  owneisliip,  40;  arguments  for,  40;  double  liability  of  stock- 
holders, 41;  par  value  of  eacii  share,  4'2 ;  provisions  of,  42;  "  Pub- 
lic Stock,"  42;  responsibility,  41;  "  United  States  stock,"  42 

"  Bank  rate,"  172 

Bank  statements,  desirable  form  of,  221 

Bankers'  balances:  in  Chicago,  282;  in  New  York,  282;  in  St.  Louis, 
282;  results  of  paying  interest  on,  2b6 

Bankers'  deposits  of  big  New  York  national  banks,  285 

Banking  legislation,  administrative  changes  in,  349 

Baring  Brothers,  failure  of,  67 

Bills  of  exchange,  open  market  operations,  175 

Blynn,  Charles  P.,  Jr.,  on  collateral  loans,  289 

Bond  values,  effect  of  decline  in,  131 

Borrowing  on  acceptances,  116 

Business  failures  in  1911,  158 

Cable  transfers,  dealings  in,  174 

Calculating  the  new  reserves,  method  of,  253 

Canada:  monetary  system  of,  16;  United  States'  gold  loss  to,  67 

Canadian  Bank  Act  of  1913,  note  issues  under,  145 

Canadian  banks,  branches  of,  57;  decentralized  reserves,  6;  ex- 
cess note  issues  taxed,  162;  limitations  on  note  issues,  145;  not 
required  to  maintain  reserve  against  deposits,  145 

Cannon's  "  Clearing  Houses,"  324 

Capital,  paid  in,  all  national  banks,  59 

Capital  requirements  of  national  banks,  43 

Central  bank  and  reserve  problem,  229 

Central  control,  effect  of,  lack  of,  16 

Central  reserve  cities,  204  ff;  burden  of  furnishing  final  payments, 
319;  burden  of  shifting  reserves,  297;  interest  in  reserve  pro- 
visions, 283 ;  new  reserve  requirements,  297 ;  old  reserve  re- 
quirements, 204;  probable  withdrawals  from,  319 

Central  reserve  city  banks:  amount  owed  to  other  national  banks, 
206;  cash  in  vaults,  206;  cash  reserve,  206;  certificates  of  de- 
posit, 224;  deposits,  206;  increase  in  profits,  36;  necessity  for 
rediscounts,  305;  probabilities  of  curtailing  loans,  310;  profits 
of,  361;  rediscounts  with,  94;  refund  to  correspondents,  320; 
savings   deposits   reported,   224 

Central  vs.  regional  banks,  9;  aid  in  distress,  11;  contrast  between 
United  States  and  Europe,  27;  found  in  leading  countries,  26; 
function  of,  9  fi";  mobilization  of  reserves,  11;  objections  to,  26; 
reasons  for  choice,  27;  responsibility  assumed,  26;  similar  in- 
stitutions in  United  States,  26 

Centralization  of  deposit  reserves,  7 

Changes  in  banking  and  currency  laws,  18 

Changes  in  banking  methods  and  in  business,  32 

Changes  in  treasury  balances,  186 

Cheap  money  for  stock  exchange  uses,  future  of,  364 

Checking  drain  of  money  to  Wall  Street,  365 

Checks  and  drafts,  methods  of  clearing,  323 

Checks  cleared  at  par  of  State  banks,  376 

Chase  National  Bank,  N.  Y.,  capital  and  surplus  of,  59 


GENERAL  INDEX  419 

Chicago,  as  an  investment  banking  center,  366;  wheat  speculation 
on  Board  of  Trade,  164;   deposit  reserves,  7 

Chicago's  deposits,  bankers'  balances,  282 

Circulating   medium,   need   for,    131 

Circulation,  money  in,  1902-11)12,  187 

City  bankers'  problems  of  readjusting  reserves,  321 

Clearing  checks  and  drafts,  323 

Clearing  house:  aboiislinient  of,  328;  aid  in  distress,  7;  Cannon  on, 
324;  collection  of  out-of-town  checks  by,  326;  emergency  methods 
of,  7;  expense  of,  329;  Federal  Reserve  Board  as  a,  91;  loan 
certificates  of,  8 

Collateral  loans:   desirability  of,  96;  vs.  commercial  paper,  288 

Collecting  checks  and  drafts,  provisions  of  new  law,  327 

Collecting  items  and  selling  cxcliange,  263 

Collecting  out-of-town  items  tlirougli  clearing  house,  326 

Collection  charges:   member  banks,  90;  reserve  banks,  89 

Collections  between  districts,  330 

Collections,   heavy  expense  of,   32') 

Commercial  credit  bills,   119 

Commercial  exchange,  facilitated,  204 

Commercial  paper:   acceptable  as  security,   164:   rediscounting,  21 

Committee  on  Inland  Excliange,  New  York  Clearing  House  report 
of,  325 

Compelling  banks  to  enter,  35 

Competition  in  purchase  of  United  States  securities,  177 

Comptroller  of  the  Currency:  report  for  1911,  158;  report  for  1912. 
125;  report  showing  relative  amount  of  inonev  in  treasurv  and 
in  circulation,   1902-1912,   187 

Compulsory  subscription.  39 

Computations  showing  required  readjustment,  country  banks.  251  ; 
reserve  citv  banks,  267,  272,  275;  central  reserve  city  banks, 
299,  .301,  .306.  320 

Computing  relative  profits,  method  of,  344,  345 

Conant,  Charles  A.,  on  rediscounting.   113 

Concentration  of  money  in  New  York  City,  362 

Congress  may  amend  or  repeal  National  Bank  Act,  41 

Contraction  of  loans  possible,  322 

Contrast  between  United  States  and  Europe.  27 

Conversion  of  State  banks  into  national  banks,  42 

Cooperation   of  European  central  banks,   67 

Cooperation  of  existing  banks,  250 

Correspondence  of  treasury  receipts  and  disbursements,  188 

Correspondents,  treatment  by  reserve  agents  of,  245 

Cortelyou,  Secretary,  operations  of,  197 

Cotton  exports:   financing  of.   121 

Country  bankers:  possible  difTiculty  witli  renewed  paper.  Ill;  Taylor 
Vinson.  Ill 

Country  banks:  ability  to  finance  their  payments,  270;  advantages 
to.  349:  assuming  country  banks  force  entire  payments  on 
others,  274;  business  ndvantafjes  of  membfrsliip.  .349:  can  bal- 
ances with  reserve  agents  be  made  more  profitable?  347:  cash 
held  bv,  47;    rash    in   vaults  Oct.  21,    1913,  206;   cash   reserves 


420  GENERAL  INDEX 

Oct.  21,  1913,  205;  cash  reserves  can  be  shifted  to  Federal 
reserve  banks,  244;  cash  reserves  required,  203;  control  of  re- 
serve adjustments,  240;  due  from  banks  Oct.  21,  1913,  206; 
effect  of  the  new  system,  343;  liberal  loans  no  longer  assured 
by  competition,  246;  method  of  computing  relative  profits,  344; 
new  reserve  requirements,  243;  payments  required  within  first 
three  years,  254;  policy  of  in  re  lower  reserve  requirements, 
241;  probable  results  if  minimum  is  withdrawn,  267;  profits 
may  be  cut,  343;  proportion  of  present  reserve  balances  remain- 
ing, 258;  proposals  by,  concerning  reserves,  232;  readjustment  of 
cash  reserves,  251  (table)  ;  readjustment  of  reserves,  240;  re- 
serve balances,  261;  results  if  they  withdraw  one-half  of  their 
payments,  271;  rigid  new  reserve  requirements,  248;  savings 
deposits  reported,  224;  shifting  reserves,  257,  260;  time  cer- 
tificates of  deposit,  224 

Country  bank  reserves,  large  reduction  in,  240,  241;  table,  259 

Currency  Act  of  March  14,  1900,  18,  194;  reaffirmed,  195 

Currency  trust  fund,  194 

Curtailment  of  loans,  probabilities  of,  310 

Daily  statement.  Treasury  Department,  190 

Dangers  of  old  reserve  system,  207 

Dawson,  A.  F.,  on  reserves,  202;  on  bankers'  balances,  215 

"  Dead  reserves,"  106 

Decentralized  reserves,  5,  6;  European  and  Canadian  conditions,  6 

Defects  of  national  banking  system,  1-17 

Demand  deposits,  223 

Demand  for  reserve  banks,  33 

Denominations  of  Federal  reserve  notes,  148 

Deposits:    individual   Oct.   21,    1913,   206;    interest  on,   61;    reserves 

on  savings  and  time  deposits,  223 
Deposit  reserves:   abolition  of  present  system,  227:  centralization  of, 

7,  282;  in  Chicago,  7;  in  New  York,  284  fT;  iii  St.  Louis,  282 
Deposit  reserve  system  brought  about  panic  of  1907,  205 
Deposit  reserve  system:  failure  of,  205;  weaknesses  of,  205 
Deputy  chairman  and  deputy  Federal  reserve  agent,  52 
Differences  between  notes  and  deposits,   145 
Digest  of  powers  of  Reserve   Board,   76 
Direct  lending  by  out-of-town  banks,   290 
Directors,    Federal    Reserve    Board:   compensation    of,    53;    term   of 

office  of,  70 
Directors,  reserve  banks,  51-54;  must  be  fair  and  impartial,  63 
Disadvantages  of  national  banks  in  dealing  with  farmers,  333 
Disadvantages   of   State  banks  entering  the  system,   377 
Discount  rate  as  a  protection,  179    (see  Rediscounting,  Gold,  Open 

Market  Operations) 
Discrimination,  fear  of,  64 

Dissolution  of  reserve  banks,  provisions  for,  66 
Distribution  of  loans  of  New  York  banks,  289 
Districting  the  United  States,  29,  59 
"  District  Reserve  Elector."  52 
Districts:   importance  of  distributing,  85;  number  to  be  established, 

31;   size  and  strength  of,  33 


GENERAL  INDEX  421 

"Dollar  drafts,"   127;   discrimiiiatioii  agaiust,   170 

Documentary  credit  bills,  117 

Domestic  withdrawals  of  gold  suppl}',   178 

Double  liability  of  stockholders,  41 

Dun's  Review  on  business  failures  in  1911,  158 

Effect  of  new  system  on  country  banks,  343 

Effect  of  Reserve  Act  on  Treasury   methods,   I'JG 

Effectiveness  of  methods  to  control  gold  supply,  182 

Elasticity:  present  lack  of,  14;  of  Federal  reserve  notes,  15G 

Eligibility  to  membership,  42,  43 

Emergency  methods,  Clearing  House,  7 

England,  public  ownership  of  Rank  of,  39 

Entering  the  system,  34,  80;   disadvantages  of,  370 

Europe  and  United  States  contrasted,  27 

European  acceptance  market,  115 

European  central  banks:  cooperation  of,  07;  interest  rates  of,  62 

European  centralized  reserves,  0 

Examinations:   modification  of  system  of  fees,  351;   new  provisions 

concerning,  350 
Excessive  issues  of  Federal  reserve  notes,  possibility  of,  149 
Expense  in  making  collections,  heavy,  325 
Exports,  financing,  121 
Extra  legal  devices  in  panics,  8 

Factors  determining  bank  reserves,  220 

Failure  of  reserve  city  and  central  reserve  city  banks  unlikely,  355 

Farm  mortgages:  advantages  of,  330;  advocated  by  Western  banks, 
339;  to  national  banks,  24;  provisions  of  Reserve  Act  concerning, 
339,  340 

Federal  Advisory  Council :  importance  of,  83 ;  personnel  of,  22 : 
powers  of,  22 ;    danger   in,  82   ff 

Federal  Reserve  Agent:  appointment  of.  37;  chairman  of  Board  of 
Directors,  51;  compensation  of,  53;  duties  of,  51 

^^ederal  Reserve  Hanks:  act  as  Clearing  House  to  members,  233; 
inability  to  loan  directly  on  market,  302;  incorporation  of,  37 
(see  Reserve  Hanks)  ;  location  of,  38;  weekly  statement  of  lia- 
bilities and  resources  of   (chart),  38 

Federal  Reserve  Board:  as  a  Clearing  House,  91;  check  upon  in- 
llation,  107:  compensation  of  directors,  reviewed  by,  jii+  control 
of  member  banks,  89;  control  of  reserve  banks,  88;  digest  of 
powers,  TOj^  fixing  salaries  of  bank  examiners,  9T;  fixing  col- 
lection charges  of  reserve  banks,  89;  fixing  collection  charges  of 
member  banks,  90;  liiyitations  on,  81;  membership  to  be  di- 
vorced from  control  of  banks,  72;  note  issues,  22;  personnel  of, 
22;  powers  classified,  85;  powers  of  supervision  ami  control,  21, 
22;  qualifications  for  mcMihersliip,  71;  redisc<ninting  commer- 
cial paper,  21;  responsibility  of,  91;  salaries  of,  22;  should  the 
bankers  control  the  Board?  55;  8ui)ervision  of  note  issues,  87; 
supervision  of  open  market  operations,  88;  supervision  of  retire- 
ment of  and  substitution  for  national  bank  notes,  91  ;  super- 
vision of  rediscounts,  80;  supremacy  of,  84;  term  of  otlice,  70; 
vacancies,  72;  work  of  organization,  85 


422  GENERAL  INDEX 

Federal  reserve  notes:  denominations  of,  148;  efl'ect  of  interest  on, 
IG'J;  elasticity  of,  15G;  excessive  issues,  149;  extent  of  issue,  63; 
inability  to  use  for  reserves,  23G;  inflation  feared,  152;  may 
cause  gold  exports,  179;  method  of  issuing,  14J;  need  for  in- 
creased lending  power,  153;  not  always  profitable,  168;  not 
legal  for  reserves,  153;  obligations  of  United  States,  146;  Owen's 
statement,  157;  promises  of  the  government,  162;  prompt  con- 
traction, 156;  redeemable  in  gold,  147;  redemption  process  de- 
scribed, 154;  redemption  process  hastened,  150;  rediscounting 
to  secure,  110;  reserve  requirements,  148;  safety  of,  157;  state 
banks  and,  146-147;  when  issued,  151 

Fictitious  reserves,  214;   illustration  of,  209 

Final  payments  will  fall  on  central  reserve  cities,  319 

Final  stage  in  readjustment  of  reserves,  317 

Financing  foreign  trade,  American  practice,    120 

Financing:  exports  of  cotton,  121;  imports  with  aid  of  an  accept- 
ance, 118;  our  imports,  122;  payments  for  customers  in  great 
centers,  204;  the  farmer,  337 

First  Bank  of  the  United  States,  1791-1811,  26,  39 

First  National  Bank  of  New  York,  capital  and  surplus  of,  59 

Fixed  minimum   reserves,  234 

Foreign  acceptances:  aid  to  our  foreign  trade,  127;  borrowing  on 
an  acceptance,  116;  commercial  credit  bill,  117;  creation  of 
market  in  United  States,  115;  disadvantages  of  our  methods, 
123;  development  of  in  United  States,  125;  documentary  bills, 
illustration  of,  117;  financing  imports,  118;  in  Europe,  115;  in 
South  America,  115;  limitations  of  new  law,  124 

Foreign  accounts:   accumulation  of,  181;  creation  of,  181 

Foreign  branches,  24;   authorization  of,   352 

Foreign  correspondents  and  agents,  176 

"Foreign   Credits,"   Archibald  J.   Wolfe  on,   128 

Foreign  exchange  house,  in  competition  with,   181 

Foreign  exchanges,  control  of,  171 

Foreign  exchange  situation  strengthened,  183 

Foreign   practice,   73;    bank  acceptances,   115,   116 

Foreign  trade:  financing,  120;   inability  to  finance,  17 

Frame,  Andrew  J.,  11;  advocates  transfer  of  reserves  to  Federal 
reserve  banks,  232;  method  of  raising  money  through  invest- 
ments, 96;   on  foreign  acceptances,   125 

France,  payment  of  war  indemnity  to  Germany,  250;  public  sub- 
scriptions, 40 

Franchise  Tax,  reserve  banks,  65 

General  fund,  government  deposits,  192 

Germany:  war  indemnity  paid  by  France,  250;  public  subscriptions, 
40 

Gilbert,  Alexander,  New  York  City  bank  loans,  289,  291 

Gold:  buying  and  borrowing,  175;  coin,  little  in  circulation,  13: 
conservation  of  supply,  171;  difficulty  in  securing  to  make  cash 
pavments,  48;  purchasing  abroad,  180:  exports,  179;  purchas- 
ing power  of.  13:  $14,000,000  loss  to  Canada,  67 

Gold  Standard  Act,  194 


GENERAL  INDEX  4«3 

Gold  standard  reaflirmed,  195 

(jiold  reserve,  amount  of,   l'J4 

Gold  reserve  fund,  VJ-k 

Gold  supply:  accumulating  foreign  accounts,  181;  buying  gold  and 
selling  securities,  180;  competition  keen,  172;  control  of,  172; 
cooperation  among  reserve  banks,  182;  discount  rate,  178;  do- 
mestic withdrawals,  178;  elfectivent  ss  of  available  methods,  182; 
suspending  reserve  requirements,   182 

Government  deposits,  184;  in  national  banks,  192;  in  treasury  of 
Philippine  Islands,  192;  in  United  States  Treasury,  192 

Government  funds,  deposit  of,   196 

Government  issues,  13 

Government  promises  to  pay,  Federal  reserve  notes,  162 

Government  stock  subscription:   in  Sweden,  40;  in  United  States,  39 

"  Gross  deposits,"  definition  of,  216 

Handling  of  reserves,  unscientific  and  ineffective,  202 
Hanover  National   Bank,  New   York,  capital   and  surplus  of,  59 
Hearings  on  Federal  Reserve  Act,  20 
Hepburn,  A.  Barton,  on  advantages  of  rediscount,  98 
Hitchcock,  Senator,  examinations  by,  211,  215 

Hoarding:  effect  on  banking  situation,  185;  in  independent  treasury 
system,  17;  in  panics,  12;  through  treasury  operations,  187 

Imports,   financing   of,    118,    122 

Improvements  in  banking  and  currency  laws,   18 

Independent  bank   system,   development  of,   2 

Independent  treasury  system:  defects  reviewed,  185;  difRculties 
arising  from,  185;  establishment  of,  184;  hoarding  in,  17; 
preservation  of,   185;   reasons  for,   184 

Individual  deposits,  Oct.  21,  1913,  206;  subject  to  check,  224 

Inelastic  money  supply,  143 

Inflation:  bankers'  responsibility  for,  165;  checks  against.  103-165; 
definition  of,  IGO;  effect  of  interest  on  notes  on.  169;  insufficient 
provision  against,  162:  methods  of  checking,  167:  Keserve  Board 
must  supervise,   167;   Elihu   Root's  views  on,   161 

Ingle,  William,  207,  208,  211 

"  Interchange  of  Credit,"   effect  of,  210 

Interest:  effect  on  issue  of  Federal  reserve  notes,  169;  European 
central  banks  do  not  pay  on  deposits,  62 ;  on  bankers'  balances, 
286;  on  deposits,  217:  on  reserve  balances,  237-238;  on  United 
States  deposits,  62:  present  rates  high,  3 

Interlocking  directorates,  69 

International  assistance  and  coJipcration,  need  for,  69 

Investing  bank  funds,  10,  97 

Italy,  public  subscriptions  in,  40 

Jackson,  Andrew,  26 

Joint  stock  banks  in  London,  reserve  requirements  of,  227 

Kansas,  State  banks  in,  377 
Kuhn,  Tyoeb  &  Co.,  99 


424  GENERAL  INDEX 

Law,  F.  M.,  rediscounts,  103 

Legislative  changes  in  banking  and  currency  laws,  18 

Liberal  lending  in  panics,  12 

Liberal  surplus  reserve,  wisdom  of,  239 

Limitations:   of  reserve  banks  in  rediscounting,  101;  on  note  issuer, 

145;    on   real   estate   loans  of  national   banks,   332;   on   reserve 

banks,  173 
Limits  in  readjusting  reserves,  objections  to,  234 
Liquid  assets,  211 
Lloyd's  Bank,  total  resources  of,  GO 
Loan  certificates,  clearing  house,  8 

Loans  and  discounts  of  national  banks,  Oct.  21,  1913,  96 
Loans  of  country  banks,  246-247 

London  County  and  Westminster  Bank,  resources  of,  60 
Lowered   reserve   requirements,  49 
Lowering  vault  reserves  at  end  of  three  years,  slight  effect  of,  320 

McAdoo,  Secretary,  197 

McRae,  Thomas  C,  on  rediscounts,  103 

Maintenance  of  present  exchange  accounts,  331 

Market  operations,  close  supervision  of,   171 

Maturities,  ninety  days,  104;  six  months,  105 

Member  banks:    act  as  collection  agencies,   110;   cash  requirements 

for,  151;  restrictions  on  note  issues,  180 
Membership,  eligibility  to,  42.   43 

Mercantile  Trust  Co.  of  St.  Louis,  real  estate  loans  by,  338 
Methods  of  calculating  the  new  reserves,  253 
Methods  of  handling  problem  of  shifting  reserves,   304 
Michigan,  opinion  of  Attorney-General  on  state  banking  law  of,  373 
Missouri:  opinion  of  Governor  and  Attorney-General  on  state  banking 

law  of,  373;   state  banks  of,  377 
Mobilization  of  reserves,  11,  202,  205 
Modification  of  system  of  examination  fees,  351 
Money:  elasticity  difficult  to  secure,  143;  expansion  and  contraction 

of,  16;  government  issues,   13;   in  control  of  banks,  table,  187; 

inelastic  supply  of,  143;  national  bank  issues,  13;  weakness  in 

our  system  of,  12 
"  Money  Trust,"  20,  56,  69,  284 
Mortgage  investments,  banking  limitation  on,  342 
Mortgages:  can  national   banks  deal   in,  340;    why  national  banks 

have  been  denied  right  to  buy,  335 
Municipal  securities,  short  term,  180 

National  Bank  Act:  capital  requirements  of  national  banks  in,  43; 
Congress'  right  to  amend,  repeal  or  alter,  41 ;  history  of,  1 ; 
present  reserve  system  under,  203 ;  restrictions  imposed  upon 
State  banks  by,  45 
National  banking  system:  defects  of,  1-17;  reformation  of,  3 
National  banks:  advantages  of.  368;  acting  as  reserve  agents,  368: 
cash  and  paper  reserves  held  by,  Oct.  21,  1913,  206:  depositaries 
of  Federal  government,  369:  disadvantages  of  in  dealing  with 
farmers,  333;  failures  of  in  1911,  158;  lending  at  critical  times, 


GENERAL  INDEX  426 

16;  limitations  on  real  estate  loans,  332;  loans  and  discounts  of, 
96;  may  continue  to  issue  notes,  132;  mortgage  purchases,  335, 
340;  New  York  City's  paid-in  capital,  59;  New  York  district's 
paid-in  cai)ital,  59;  prestige  of  name,  370;  ready  to  enter,  36; 
reduction  of  reserves,  222;  savings  deposits,  225;  securities  owned 
by,  Oct.  21,  1913,  96;  strength  of,  3 

National  bank  notes:  as  reserves,  372;  circulation  in  iiands  of  public, 
16;  circulating  medium  needed,  131;  direct  obligation,  14;  elas- 
ticity of,  insullicient,  16;  bard  to  eliminate,  130;  not  counted  as 
reserves,  15;  policy  concerning  uncertain,  137;  profits  on  issues 
of,  15,  135;  reasons  for  issuing,  136;  redem|)tion  fund,  15;  re- 
demption of,  rapid,  154;  retiring  of,  132-135;  security  of,  14: 
state  banks  may  continue  to  use,  147  ;  value  in  times  of  stress,  15 

National  bank  stockliolders,  organization  of  state  institutions,  334,  335 

National  City  Bank,  New  York:  acceptances.  124;  capital  and  sur- 
plus of,  59;  classification  of  loans  of.  293,  294;  possibility  of 
failure  of,  60;   Frank  A.  Vanderlip,  100 

National  Currency  Association,  18 

National  debt,  reduction  of,  142 

National  Monetary  Commission:   appointment  of.   19 

Nelson,  Senator,  2*18,  224 

"  Net  Deposits,"  216,  253 

New  reserve  requirements:  central  reserve  cities,  297;  country  banks, 
243 ;   reserve  city  banks,  265 

New  York:  aililiations  of  banks  in,  284;  deposit  reserves,  7;  dis- 
tribution of  loans,  280;  district's  paid-in  capital,  59;  effect 
of  reduction  in  loans,  311;  effect  of  witlidrawals  of  bankers' 
deposits  in  central  reserve  cities,  283;  financial  supremacy  of, 
366;  most  important  subtreasury,  184;  panic  of  1907  in,  8; 
rediscounts  in,  95,  108;  small  reserves,  8;  universal  interest  in, 
364 

New  York  banks:  distribution  of  loans,  289;  great  investors  in  com- 
mercial paper,  293;  have  been  central  banks,  286;  partiality  to 
collateral  loans.  293;  proportion  of  loans  to  brokers,  291;  rela- 
tions with  stock  exchange  operations,  289;  reserve  policy  of,  287 

New  York  Clearing  House:  criticisms  of  paying  interest  on  bankers' 
balances,  286;  excerpt  from  report  of  committee  appointed  bv, 
217 

New  York  deposits,  half  bankers'  balances,  282 

New  York  national  banks,  bankers'  deposits  of,  285 

New  York  State  banks,  reserve  requirements,  375 

Ninety-day  maturities.  104 

Note  issues:  Federal  Reserve  Act,  22;  power  of  reserve  banks,  64; 
supervision  by  Reserve  Board,  87 

Objections  to  changing  reserve  arrangements,  245 

Old  and  new  systems,  relative  profits  under,  345,  356.  360 

One-year  gold  notes,  issued  to  reserve  bank,  141 

Open  market  operations.  170;  advantages  of,  171:  bankers*  accept- 
ances, 176;  bills  of  exchange,  175;  buying  and  selling  securities. 
176;  cable  transfers,  174;  Federal  Reserve  Board  supervision.  65. 
88:  foreign  correspondents  and  agents,  176:  gold  buying  and 
borrowing,  175;  limitations  of  reserve  banks  in,  173 


426  GENERAL  INDEX 

Optional  reserves  may  be  transferred  to  reserve  banks,  318 

Order  of  Secretary  of  Treasury  in  re  ciiange  in  manner  of  handling 

and  disbursing  public  funds,  189 
Oriental  Bank  failure,  355 

Out-of-town  bank  deposits,  Pujo  Money  Trust  investigation,  284 
Out-of-town  banks,  direct  lending  of,  in  New  York,  290 
Out-of-town  checks,  collected  through  clearing  house,  326 
"  Outside  items,"  210 

Owen,  Senator,  on  security  of  Federal  reserve  notes,   157 
Owen-Glass  bill,  20 
Ownership  and  control,  difference  between,  40 

Panama  3  per  cent  bonds,  134 

Panic  of  1907:  Bank  of  England's  assistance  in,  67;  basis  for 
Federal  Reserve  Act,  1913,  5;  brought  about  by  system  of  de- 
posited reserves,  205;  extra  legal  devices  in,  8;  rediscounting  in 
New  York  during,  95 

Panics:  1893,  96;  frequency  of,  4;  high  interest  rate,  3;  hoarding 
during,  12;  less  frequent  in  European  countries,  9;  liberal  lend- 
ing, 12;  prevention  of,  4 

Paper  reserve,   206 

Payments  required  of  country  banks  within  the  first  three  years,  254 

Penn  National  Bank,  statement  of,  221 

Philadelphia  system  of  deferred  interest  on  checks  and  drafts,  326 

Philippine  Islands,  deposit  of  public  funds,  196;  government  deposits 
in  treasury  of,  192 

Position  of  reserve  cities,  262 

Possibilities  co:.cerning  extent  of  withdrawals,  298 

Postal  savings,  deposit  of,  196 

Powers  of  Federal  Eeserve  Board,  analysis  of,  85-91 

Powers  of  Secretaries  of  Treasury,  large,  197 

Present  exchange  accounts,  maintenance  of,  331 

Present  methods  of  handling  checks  and  drafts,  324 

Present  reserve  balances  of  country  banks,  proportion  remaining,  258 

Present  reserve  system,  203 

Profitableness  of  balances  of  country  banks  with  reserve  agents,  347 

Profits  of  country  banks,  effect  of  new  system  on,  343 

Profits  of  reserve  banks,  65;  on  note  issues,  135 

Profits  under  old  and  new  systems,  356 

Provisions  of  new  law  concerning  collecting  checks  and  drafts,  327 

Public  discount  market,  present  lack  of,  17 

Public  funds,  change  in  methods  of  handling  and  disbursing,  189 

Public  opinion  as  a  controlling  force,   199 

Public  stock,  bank  ownership  of,  42 

Public  subscriptions:  England,  39;  France,  40;  Germany,  40;  Italy, 
40;  history  of  in  United  States,  39;  Reichsbank,  39;  value  of,  39 

Purchasing  power  of  gold,  13 

Purposes  of  new  law,  summary  of,  170 

Pyramiding  of  reserves,  206 

Qualifications  for  membership  on  Federal  Reserve  Board,  71 


GENERAL  INDEX  427 

Raising  funds,  courses  of  action  open  to  central  reserve  city  banks, 
309 

Readjusting  reserves,  objections  to  fixing  limits  in,  234 

Readjustment  of  reserves:  aided  by  Secretary  of  Treasury,  255;  final 
stage  in,  317;  successful  accoinplisliment  of,  312 

Readjustment   of   reserves   in   reserve   cities,    202 

Real  estate  loans,  332,  338 

Reasons  for  reserve  system,  204 

Receipts  and  disbursements  of  government  in  1912-13,  189 

Redemption  fund:  eliminated  from  reserves,  242;  not  counted  as 
reserves,  47;  must  remain  in  vaults  of  Treasury  Department, 
196 

Redeposited  reserves,  207 

Redepositing  of  reserves,  220 

Rediscounting:  aid  of  brandies,  114;  Aldricli  plan,  114;  advantages 
claimed,  97;  advantages  to  business  community,  100;  arguments 
for  and  against,  108;  by  reserve  city  banks,  280;  by  central 
reserve  city  banks,  93;  Charles  A.  Conant  on,  113;  definition  of, 
93;  Federal  Reserve  Board  supervision  of,  SO;  financing  with- 
drawals from  central  reserve  city  banks  by,  305;  A.  Harton 
Hepburn's  illustration  of,  98;  F.  M.  Law  on  maturities,  103; 
Thomas  C.  McRae  on  maturities,  103;  necessity  for,  30");  need 
of  in  crises,  92;  New  York  banks,  95,  109;  ninety-day  maturities, 
104;  of  commercial  paper,  21,  62;  of  direct  obligations.  65; 
panic  of  1907  and,  95;  probable  extent  of,  107;  provisions  con- 
cerning, 92;  renewed  paper.  111;  reserve  city  banks,  94;  re- 
sponsibility of  bankers,  113;  George  M.  Reynolds  on  maturities, 
103;  six-months  maturities,  105;  statistics  of,  108;  supervision 
of  Federal  Reserve  Board  over,  86;  to  create  balances  with  re- 
serve banks,  307;  to  secure  notes,  100;  Samuel  Untermyer  on, 
102;  Frank  A.  Vanderlip  on,  100;  Taylor  Vincent  on.  111 

Reduction  in   loans,  cities  afTected  by,  311 

Reduction  of  reserves  of  national  banks,  222 

Reduction  of  reserves  on  time  deposits,  220 

Reformation  of  national   banking  system,  agitated,   3 

Refunding  2  per  cent  United  States  bonds,  40 

Regional  plan,  28 

Regional   reserve  centers,  system   of  three  advocated,  230 

Regional  system,  advantages  of,  207 

Regional  system  and  tlie  reserve  problem,  228 

Reichshank:  branches  of,  57;  no  legal  restrictions  as  to  member- 
ship on  directorate  of,  73;   public  subscriptions  to  stock  of,  39 

Report  of  committee  appointed  by  New  York  clearing  house,  217 

Reserve  adjustments,  controlled   by  country   banks,  240 

Reserve  agents:  effect  on  balances  with,  270;  liberal  treatment  of 
correspondents   by,   245 ;    national   banks   as,   308 

Reserve  balances:  country  banks,  201;  interest  on,  237,  238;  pro- 
portion to  be  withdrawn,  232;  sliifting  of,  249 

Reserve  banks:  average  strength  of,  58;  autliority  and  responsiltjlity 
of  branches,  57;  bond  secured  notes  of,  151;  branches  will  pre- 
vent unfair  advantages  to  city  containing  main  office,  57;  closely 


428  GENERAL  INDEX 

limited,  173;  competition  witii  foreign  exchange  houses,  181; 
cooperation  among,  182;  demand  for,  33;  directors  of,  51-54, 
63,  150;  franchise  tax,  05;  interest  upon  deposits  in,  01;  limita- 
tions of,  101;  necessity  for  careful  districting,  59;  necessity  for 
branches,  50;  open  marlvet  operations  of,  05;  organization  of, 
51;  possibility  of  failure  of,  59;  power  of  note  issue  by,  04; 
profits  of,  05;  provision  for  dissolution  of,  06;  rediscounting  by, 
62,  65,  101;  required  casii  payments  to,  270;  resources  of,  58-00; 
summary  of  powers  of,  00;  total  paid-in  capital  if  all  national 
banks  enter,  59;  work  of,  21 

Reserve  bank  notes:  create  a  market  for  United  States  bonds,  140; 
need  for,  138;  occasions  for  issuing,  139;  refunding  2  per  cent 
bonds,  140;  similarity  to  national  bank  notes,  138;  tax  upon 
issue  of,   139 

"Reserve  Bank  Organization  Committee,"  21;  announcement  of 
Dec.  26,  1913,  30;  districting  the  United  States,  29;  duties  of, 
21;  organization  of  reserve  banks  by,  51;  plan  of  action,  30; 
prompt  action  possible,  37 

Reserve  cities,  203,  204;  position  of,  262;  shifting  reserves,  265 

Reserve  city  banks:  ability  to  finance  their  payments,  270;  advan- 
tages of  membership,  354;  amount  owed  Oct.  21,  1913,  206;  cash 
in  vaults,  206;  cash  reserves,  205;  due  from  banks,  206;  effect 
on  balances  with  reserve  agents,  270;  forced  into  system  by  the 
Act,  355;  gradual  reduction  of  reserves,  269;  methods  of  rais- 
ing funds,  309;  new  reserve  requirements,  205;  rediscounting, 
94,  280;  reserve  required,  204;  reserve  requirements,  table,  208; 
resources  of,  202;  savings  deposits  reported,  224;  strong  position 
of,  279;  time  certificates  of  deposit,  224 

Reserve,  importance  of  good  reserves,   100 

Reserve  requirements:  Federal  reserve  notes,  148;  for  country  banks, 
243,  248,  251;  for  member  banks,  23,  44;  new,  205;  suspension  of, 
182 

Reserve  situation,  reform  of,  302 

Reserves:  determination  of,  220;  Federal  reserve  notes  not  legal 
for,  153;  methods  of  calculating,  253;  mobilization  of,  202;  ob- 
jections to  changing  arrangements  of,  245;  proportion  available. 
222;  system  of  handling,  202 

Reserves  in  reserve  cities:  probable  course  followed,  278;  solutions 
of  problem,  273 

Reserves  of  national  banks  less  than  indicated,  205 

Reserves  on  time  deposits,  223 

Resources  of  Federal  reserve  banks,  58-60 

Resources  of  reserve  city  banks,  262 

Required   cash  payments   to   reserve   banks,   270 

Restrictions  imposed  upon  State  banks  that  become  members,  45 

Retirement  of  national  bank  notes,  132-134 

Retirement  of  United  States  notes  or  greenbacks,  suggested,  14 

Retirement  process  limited,  135 

Reynolds,  George  M.,  103,  208  fT,  218,  295 

Root,  Elihu,  161 

Russian  Imperial  Bank,  67 


GENERAL  LXDEX  429 

Safety  of  reserve  banks,  354 

St.  Louis,  bankers'  balances  in,  283 

Salaries  of:  bank  examiners,  91;  directors  of  Federal  Reserve  Board, 
53;  Federal  reserve  agents,  53;  Federal  Reserve  Board,  22 

Savings  deposits  of  national   banks,  225 

Savings  deposits  reported,  224 

Savings  deposits,  reserves  on,  223 

Savings  fund  societies,  extra  legal,  223 

Scott,  J.  F.,  on  mobilization  of  reserves,  202 

Seasonal  withdrawals  of  monev,  205 

Second  Bank  of  the  United  States,  1810-1836,  20.  39 

Secretary  of  the  Treasury:  authority  of,  197;  criticism  against,  197; 
deposits  in  national  banks,  192;  deposits  in  treasury  of  Philip- 
pine Islands,  192;  illustration  of  use  of  power,  198;  importance 
of  position,  199;  may  continue  to  deposit  witli  national  banks, 
190;  order  inaugurating  changes  in  handling  public  funds,  189; 
power  of,  82;  power  for  good,  198;  power  for  evil,  199;  transfer- 
ring funds  from  reserve  banks,  199 

Securities  owned  by  national  banks  Oct.  21.  1913,  90 

Securing  cash,  problem  of  readjustment.  304 

Securities:  buving  and  selling,  170;  owned  by  national  banks  Oct. 
21,   1913,  96;   power  to  sell,  180 

Senate  Committee  on  Banking  and  Currency,  witnesses  fear  discrimi- 
nation, 64 

Shaw,  Secretary,  197 

Shifting  reserves:  burden  of  central  reserve  cities,  297;  country 
banks,  258,  200;  methods  of  handling  problem,  304;  periods  of 
stress,  316;  reserve  cities,  265;  six  steps  in,  316 

Short  term  paper,  221 

Short  term  state  and  municipal  securities,  180 

Short  time  collateral,  165 

Silver  dollar,  worth  of,  13 

Six-montlis   maturities,   105 

Six  steps  in  shifting  reserves,  310 

Solutions  of  reserve  problem,  273 

South  Aiiiorica,  acceptance  market  in,  115 

Sprague,  Prof.  O.  M.  W.,  04,  131 

State  banks:  advantages  of  in  past.  370;  advantages  to,  in  entering 
system,  374;  advantages  of  real  estate  loans.  332:  checks  cleared 
at  par,  376;  converted  into  national  banks.  42:  effect  of  new 
legislation  on,  373;  experience  with  mortgage  lending,  338;  im- 
portance to  system.  377;  increase  of.  2:  investments  not  closply 
limited,  371;  late  applications  for  membership,  45;  lowered  re- 
quirements of,  372;  national  bank  notes  as  reserves,  372:  new 
reserve  requirements.  375:  organized  by  national  bank  stock- 
holders. 334;  popularity  of,  2:  powers  of.  2;  rediscounting  and 
securing  reserve  notes,  374:  relation  to  the  reserve  city  problem, 
264;  requirements  and  examinations  less  strict.  2;  restrictions 
imposed  upon  State  banks  who  become  members,  45 ;  wide  latitude 
of.  332 

State  member  banks  may  continue  to  use  national  bank  notes.  147 

State  securities,  short  term,  ISO 


430  GENERAL  INDEX 

stock  exchange,  availability  of  cheap  money  for,  364 

Stock  exchange  loans,  as  a  possible  source  from  which  central  re- 
serve city  banks  can  make  up  deficit,  312 

Stock  excliange  operations,  relations  of  New  York  banks  with,  289 

Stock   exchange  speculation,   methods  of   financing,   366 

Stock,  public,  42;   United  States,  42 

Stock  subscriptions,  45;  cancellation  of  insolvents'  subscriptions,  46; 
difliculty  in  making  payments,  48;  form  of  payment,  46;  reduc- 
tion of  capital  stock  by  member  banks,  46;  time  of  payments,  46; 
ways  of  avoiding  friction,  50 

Stockholders,  increased  liability  of,  352 

Strength   of   national   banks,   3 

Strong  position  of  reserve  city  banks,  279 

Subscription,  compulsory,  39 

Suggestions  for  avoiding  friction  in  making  capital  payments,- 49 

Summary  of  provisions  of  the  Act,  266 

Summary  of  powers  of  reserve  banks,  60 

Surplus  reserve,  should  be  liberal,  239 

Suspending  reserve  requirements,  182 

Sweden,  government   subscriptions,   40 

Switzerland,  public  subscriptions,  40 

System  of  handling  reserves,  202 

Tables:  analysis  of  withdrawals  and  balances  which  reserve  banks 
have  on  deposit  with  central  reserve  agents,  276 ;  bankers'  de- 
posits of  big  New  York  national  banks,  285 ;  calculations  based 
on  average  institution,  360 ;  compilation  of  relative  profits  for 
average  city  bank,  345 ;  country  bank  reserves,  259 ;  effect  of 
assumptions  concerning  withdrawals  upon  central  reserve  city 
banks,  301;  effect  upon  bank's  income,  345,  356,  360;  financing 
withdrawals  from  central  reserve  city  banks  through  rediscounts, 
306;  New  Y^ork  City  bank  loans,  290;  possibilities  concerning 
extent  of  withdrawals  from  central  reserve  city  banks,  299 ; 
relative  profitableness  of  average  reserve  city  bank,  357;  reserve 
city  banks,  assuming  that  country  banks  withdraw  one-half 
from  reserve  city  banks  and  remainder  from  central  reserve 
city  banks,  275;  reserve  requirements,  reserve  city  banks,  268; 
receipts  and  disbursements  of  government,  1912-13,  189;  show- 
ing segregation  of  reserves,  267;  showing  relative  amount  of 
money  in  Treasury,  in  control  of  banks,  and  in  circulation, 
1902-1912,  187 

Taxation,  chanfs  in,  186 

Three  regional    bank  system  advocated,  230 

Time  certificp   es  of  deposit,  224 

Time  deposit    and  the  lending  problem,  336 

Time  depos'  s:   reduction  of  reserves  on,  226;   reserves  on,  223 

Token  morsy.   13 

Transferring  funds  from  reserve  banks,  199 

Treasury  balances,  186-187 

Treasury  Department:   daily  statement.  100:  requirements  of.  14 

Treasury  funds,  division  of.  190 

Treasury  receipts  and  disbursements,  correspondence  of.  188 


GENERAL  INDEX  431 

Treasury  methods,  eliect  of  Reserve  Act  on,  I'JU 
Trouble,  methods  of  preventing,  ITOj  reserve  banks,  170 

United  States:  area  of,  50;  contra8t€d  with  Europe,  27;  free  gold 
market,  08;  government  subscriptions,  39;  interest  on  deposits, 
02;   public  subscriptions,  3'J ;   slock,  bank  ownership,  42 

United  States  bonds:  create  market  for,  140;  disposition  of,  133, 
134;  refunding  2  per  cent  bonds,  140 

United  States  notes  or  greenbacks,   13 

United  States  Treasury:  amount  of  money  in  1902-1912,  187;  cash 
in  possession  of,  192 

Unscientific  system  of   handling  reserves,   202 

Untermyer,  Samuel,   102 

Vacancies,  Federal  Reserve  Board,  72 

VandCTli^gjJFrank  A.:  difference  between  gross  and  net  deposits,  210; 

rediscounfing,   100 
Vault  reserves,  lowering  of,  320 
Vinson,  Taylor,  farmers'  loans,  1 1 1 

Wade,  Festus  J.,  338 

Wall  Street,  checking  drain  of  money  to.  305 

Warehouse  receipts,   12 

Warburg,  Paul  N.,  99 

Western  banks  advocate  farm  loans,  339 

Wexler,  Sol:   bank  acceptances,   125;   contraction  of  Federal  reserve 

notes,  112;    financing  cotton  exports,   121;   rediscounts.   107 
Wheat   speculation   on   Chicago   Board  of   Trade,   104 
Wildcat  banking,  era  of,   184 

Withdrawal  of  one  half  of  payments  of  country  banks,  271 
Withdrawals,  extent  of,  313;    from  central   reserve  cities,  319 
Wolfe,  Archibald,  "  Foreign  Credits,"   128 


UNIVERSITY  OF  CALIFORNIA  LIItRARV 

Los  Angeles 
This  book  is  DUE  on  the  last  date  stamped  below. 

fiECB  U)-URC 

iAY  Z  0 1988 

Ui\Nl0l9' 

flfC-OlO-UKt 

**      MAR  27  u 

Form  L9-Series  444 

SOUTHERN    BRANC..^    ^  ^  ^^    ^^^^^    9544 

Library 

LOS   ANGELES.  CALIF. 


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